CHAPTER 7
The G20 Solution
“Let me put it simply . . . there may be a contradiction between the interests of the financial world and the interests of the political world….We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”
Angela Merkel, Chancellor of Germany, at the G20 Summit,
November 2010
The Group of Twenty, known as G20, is an unaccountable and very powerful organization that arose from the need to resolve global issues in the absence of true world government. The name G20 refers to its twenty member entities. They are a mixture of what were once the world’s seven largest economies, grouped as the G7, consisting of the United States, Canada, France, Germany, the United Kingdom, Italy and Japan, and some fast- growing, newly emerging economies such as Brazil, China, South Korea, Mexico, India and Indonesia. Others were included more for their natural resources or for reasons of geopolitics rather than the dynamism of their economies; examples are Russia and Saudi Arabia. Still others were added for geographic balance, including Australia, South Africa, Turkey and Argentina. The European Union was invited for good measure, even though it is not a country, because its central bank issues one of the world’s reserve currencies. Some economic heavyweights such as Spain, the Netherlands and Norway were officially left out, but they are sometimes invited to attend the G20 meetings anyway because of their economic importance. G20 and Friends might be a more apt appellation.
The G20 operates at multiple levels. Several times each year the finance ministers and central bank heads meet to discuss technical issues and try to reach consensus on specific goals and their implementation. The most important meetings, however, are the leaders’ summits, attended by presidents, prime ministers and kings, which meet periodically to discuss global financial issues, with emphasis on the structure of the international monetary system and the need to contain currency wars. It is at these leaders’ summits, both in the formal sessions and informally in the suites, that the actual deals shaping the global financial system are made. Interspersed among the presidents and prime ministers at these meetings is that unique breed of international bureaucrat known as the sherpa. The sherpas are technical experts in international finance who assist the leaders with agendas, research and drafting of the opaque communiqués that follow each confab. All roads toward the resolution of the looming currency wars point in the direction of G20 as the principal forum.
The G20 is well suited to be inclusive of Chinese participation. China often resists compromise in bilateral meetings, viewing requests for concessions as bullying and their assent as a loss of face. This is less of a problem in G20, where multiple agendas are implemented at once. Smaller participants enjoy the chance to have their voices heard in G20 because they lack the leverage to move markets on their own. The United States benefits from having its allies in the room and avoids charges of acting unilaterally. So the advantages of G20 to all parties are apparent.
President George W. Bush and President Nicolas Sarkozy of France were instrumental in changing the G20 from merely a finance ministers’ meeting, which it had been since its beginning in 1999, to a leaders’ meeting, which it has been since 2008. In the immediate aftermath of the Lehman Brothers and AIG collapses in September 2008, attention turned to a previously scheduled G20 meeting of finance ministers in November. The Panic of 2008 was one of the greatest financial catastrophes in history and the role of China as one of the largest investors in the world and a potential source of rescue capital was undeniable. At the time, the G7 was the leading forum for economic coordination, but China was not in the G7. In effect, Sarkozy and Bush reenacted the scene in Jaws where Roy Scheider, after seeing the shark for the first time, says to Robert Shaw, “We’re gonna’ need a bigger boat.”
Politically and financially, G20 is a much bigger boat than G7.
In November 2008, President Bush convened the G20 Leaders’ Summit on Financial Markets and the World Economy, at which every president, prime minister, chancellor or king of a member country was present. Instantly the G20 morphed from a finance ministers’ technical session to a gathering of the most powerful leaders in the world. Unlike various regional summits, every corner of the globe had its representatives and, unlike the UN General Assembly, everyone was in the room at the same time.
Based on the urgency of the financial crisis and the ambitious agenda laid down by the G20 in November 2008, the leaders’ summits continued through four more meetings over the course of 2009 and 2010. For 2011, the G20 leaders decided to hold a single meeting in Cannes, France, in November. This sequence of summits was the closest thing the world had ever seen to a global board of directors, and it seemed here to stay.
The G20 is perfectly suited to U.S. Treasury secretary Timothy Geithner’s modus operandi, which he calls “convening power.” Author David Rothkopf brought this concept to light in a highly revealing interview he conducted with Geithner for his book Superclass, about the mores of the global power elite. When he was president of the New York Fed in 2006, Geithner told Rothkopf:
We have a convening power here that is separate from the formal authority of our institution…. I think the premise going forward is that you have to have a borderless, collaborative process. It does not mean it has to be universal…. It just needs a critical mass of the right players. It is a much more concentrated world. If you focus on the limited number of the ten to twenty large institutions that have some global reach, then you can do a lot.
Geithner’s notion of convening power states that, in a crisis, an ad hoc assembly of the right players could come together on short notice to address the problem. They set an agenda, assign tasks, utilize staff and reassemble after a suitable interval, which could be a day or month, depending on the urgency of the situation. Progress is reported and new goals are set, all without the normal accoutrements of established bureaucracies or rigid governance.
This process was something Geithner learned in the depths of the Asian financial crisis in 1997. He saw it again when it was deployed successfully in the bailout of Long-Term Capital Management in 1998. In that crisis, the heads of the “fourteen families,” the major banks at the time, came together with no template, except possibly the Panic of 1907, and in seventy-two hours put together a $3.6 billion all-cash bailout to save capital markets from collapse. In 2008, Geithner, then president of the New York Fed, revived the use of convening power as the U.S. government employed ad hoc remedies to resolve the failures of Bear Stearns, Fannie Mae and Freddie Mac from March to July of that year. When the Panic of 2008 hit with full force in September, the principal players were well practiced in the use of convening power. The first G20 leaders’ meeting, in November 2008, can be understood as Geithner’s convening power on steroids.
It was in the G20 that the United States chose to advance its vision for a kind of global grand bargain, which Geithner has promoted under the name “rebalancing.” To understand rebalancing and why this has been critical to growth in the U.S. economy, one need only recall the components of gross domestic product. For the United States, GDP grew to roughly $14.9 trillion in early 2011. The components broke down as follows: consumption, 71 percent; investment, 12 percent; government spending, 20 percent; and net exports, minus 3 percent. This was barely above the level the U.S. economy had reached before the recession of 2007. The economy was not growing nearly fast enough to reduce unemployment significantly from the very high levels reached in early 2009.
The traditional cure for a weak economy in the United States has always been the consumer. Government spending and business investment might play a role, but the American consumer, at 70 percent or more of GDP, has always been the key to recovery. Some combination of low interest rates, easier mortgage terms, wealth effects from a rising stock market and credit card debt has always been enough to get the consumer out of her funk and get the economy moving again.
Now the standard economic playbook was not working. The consumer was overleveraged and overextended. Home equity had evaporated; indeed many Americans owed more on their mortgages than their houses were worth. The consumer was stretched, with unemployment high, retirement looming and kids’ college bills coming due. And it seemed the consumer would stay stretched for years.
In theory, business investment could expand on its own, but it made no sense to invest in plant and equipment beyond a certain point if the consumer was not there to buy the resulting goods and services. Besides, high U.S. corporate tax rates led many corporations to keep their earnings offshore so that much of their new investment took place outside the United States and did not contribute to U.S. GDP. Investment remained in the doldrums and would stay there as long as the consumer was in hibernation.
With the consumer out of action and investment weak, the Keynesians in the Bush and Obama administrations next turned to government spending to stimulate the economy. However, after four stimulus plans from 2008 to 2010 failed to create net new jobs, a revulsion to more spending emerged. This revulsion was fanned by a Tea Party movement, threats from ratings agencies to downgrade U.S. creditworthiness and a Republican tidal wave of victories in the 2010 midterm elections. It became clear that the American people wanted someone to put the lid back on Uncle Sam’s cookie jar. It remained to be seen how much in the way of spending cuts could be enacted, but it was apparent that greatly increased government spending was off the table.
So a process of elimination led the Obama administration to see that if consumption, investment and government spending were out of play, the only way to get the economy moving was through net exports—there was nothing else left. In the State of the Union address on January 27, 2010, President Obama announced the National Export Initiative, intended to double U.S. exports in five years. Achieving this could have profound effects. A doubling of exports could add 1.3 percent to U.S. GDP, moving growth from an anemic 2.6 percent to a much more robust 3.9 percent or higher, which might be enough to accelerate the downward trajectory of unemployment. Doubling exports was a desirable goal if it could be achieved. But could it? If so, at what cost to our trading partners and the delicate balance of growth around the world?
At this point U.S. economic policy crashed headlong into the currency wars. The traditional and fastest way to increase exports had always been to cheapen the currency, exactly what Montagu Norman did in England in 1931 and what Richard Nixon did in the United States in 1971. America and the world had been there before and the global results had been catastrophic. Once again a cheap dollar was the preferred policy and once again the world saw a catastrophe in the making.
China’s GDP composition was in some ways the mirror image of the United States. Instead of the towering 70 percent level of the United States, consumption was only 38 percent of the Chinese economy. Conversely, net exports, which produced a negative 3 percent drag on the U.S. economy, actually added 3.6 percent to the Chinese total. China’s growth was heavily driven by investment, which totaled 48 percent of GDP versus only 12 percent for the United States. Given these mirror image economies, a simple rebalancing seemed in order. If China could increase consumption, in part by buying goods and services from the United States, including software, video games and Hollywood films, then both countries could grow. All that needed to change was the consumption and export mix. China would dial up consumption and dial down net exports, while the United States did the opposite. Those new export sales to China would create jobs in the United States for good measure. This could not be done through exchange rates alone; however, Geithner said repeatedly that upward revaluation of the yuan was an important part of the overall policy approach.
One reason the Chinese did not consume more was that their social safety net was weak, so individuals saved excessively to pay for their own retirement and health care. Another factor working against Chinese consumption was a millennia-old Confucian culture that discouraged ostentatious displays of wealth. Yet U.S. policy makers were not looking for a prospending cultural revolution; something more modest would suffice. Just a few percentage points of increase in consumption by China in favor of U.S. exports could allow the United States to ignite a self-sustaining recovery.
This was to be a strange kind of rebalancing: the increased Chinese consumption and increased U.S. net exports would come entirely at China’s expense. China would have to make all of the adjustments, with regard to their currency, their social safety net and twenty-five hundred years of Confucian culture, while the United States would do nothing and reap the benefits of increased net exports to a fast-growing internal Chinese market. This was a particularly soft option for the United States. It required no tangible effort by the United States to improve its business climate by reducing corporate taxes and regulation, providing for sound money or promoting savings and investment. Some of what the United States wanted may have been in China’s best interests, but China could not be blamed for believing it was being bullied on behalf of a U.S. plan that above all suited the United States. In the parlance of the G20, “rebalancing” became code for doing what the United States wanted.
The international financial cognoscenti did not have to wait for the January 2010 State of the Union to see where the United States was going with its rebalancing plan. The idea for increased U.S. exports and the associated revaluation of the yuan had already been vetted in September 2009 at the Pittsburgh G20 summit. The first two G20 summits, in Washington and London, had been devoted to an immediate response to the Panic of 2008 and the need to create new liquidity sources through the IMF. These early G20 summits had also been preoccupied with plans to rein in the banks and their greed-based compensation structures, which provided grotesque rewards for short-term gains but caused the long-term destruction of trillions of dollars of global wealth. By the Pittsburgh summit in late 2009, the leaders felt that while vulnerabilities remained, enough stability had returned that they could look past the immediate crisis and begin to think about ways to get the global economy moving again. Pittsburgh would be the last G20 summit before the 2010 State of the Union. If the United States was going to get buy-in for its export-driven rebalancing plan, this was the time.
The Pittsburgh G20 leaders’ summit produced a breakthrough plan for the kind of rebalancing of growth that Geithner wanted. The plan was contained in the official leaders’ statement as “A Framework for Strong, Sustainable, and Balanced Growth.” It was not immediately clear how this rebalancing was to be achieved. Like all such technical statements from large multilateral bodies, it is written in a kind of global elite-speak in which plain language is the first casualty. Buried in Section 20 of the framework, however, is this passage:
Our collective response to the crisis has highlighted . . . the need for a more legitimate and effective IMF. The Fund must play a critical role in promoting global financial stability and rebalancing growth.
There was no doubt on the part of the participants that rebalancing meant increased consumption by China and increased exports by the United States. Now the IMF was being deputized by the G20 to act as a kind of cop on the beat to see to it that G20 members lived up to any obligations they might undertake in that regard. So the international foundation was laid in Pittsburgh for President Obama’s National Export Initiative announced two months later.
The G20’s use of the IMF as an outsourced secretariat, research department, statistical agency and policy referee suited both organizations extremely well. It gave the G20 access to enormous expertise without its having to create and build an expert staff on its own. For the IMF, it was more like a reprieve. As late as 2006 many international monetary experts seriously questioned the purpose and continued existence of the IMF. In the 1950s and 1960s, it had provided bridge loans to countries suffering temporary balance of payments difficulties to allow them to maintain their currency peg to the dollar. In the 1980s and 1990s it had assisted developing economies suffering foreign exchange crises by providing finance conditioned upon austerity measures designed to protect foreign bankers and bondholders. Yet with the elimination of gold, the rise of floating exchange rates and the piling up of huge surpluses by developing countries, the IMF entered the twenty-first century with no discernable mission. Suddenly the G20 breathed new life into the IMF by positioning it as a kind of Bank of the G20 or proto–world central bank. Its ambitious leader at the time, Dominique Strauss-Kahn, could not have been more pleased, and he eagerly set about as the global referee for whatever guidelines the G20 might set.
Despite this heady start toward global rebalancing and President Obama’s personal buy-in, two G20 summits came and went in 2010 with no significant progress in the commitments of member nations to the Pittsburgh summit goals. The IMF did conduct extensive reviews of the practices of each country under the heading “mutual assessment” and continued allegiance to the framework was paid in the G20 communiqués, but the ambitious goals of rebalancing were essentially ignored, especially by China.
Geithner was blunt in criticizing the Chinese for not allowing greater yuan revaluation. When asked by the Wall Street Journal in September 2010 if the Chinese had done enough, he said, “Of course not . . . they’ve done very, very little.” U.S. exports did improve in 2010, but this was mostly because of relatively high growth in emerging markets and a demand for U.S. high-tech products rather than exchange rate changes. The Chinese did allow the yuan to appreciate slightly, mostly to forestall China being branded a currency manipulator by the U.S. Treasury, which could lead to trade sanctions by the U.S. Congress. But neither of these developments came close to meeting Geithner’s demands. Even a bilateral summit in January 2011 between President Hu and President Obama, the so-called G2, produced little more than mutually cordial remarks and smiling photo ops. It seemed that if the United States wanted a cheaper dollar it would have to act on its own to get it. Reliance by the world on the G20 had so far proved a dead end.
By June 2011, however, the United States was emerging as a winner in the currency war. Like winners in many wars throughout history, the United States had a secret weapon. That financial weapon was what went by the ungainly name “quantitative easing,” or QE, which essentially consists of increasing the money supply to inflate asset prices. As in 1971, the United States was acting unilaterally to weaken the dollar through inflation. QE was a policy bomb dropped on the global economy in 2009, and its successor, promptly dubbed QE2, was dropped in late 2010. The impact on the world monetary system was swift and effective. By using quantitative easing to generate inflation abroad, the United States was increasing the cost structure of almost every major exporting nation and fast-growing emerging economy in the world all at once.
Quantitative easing in its simplest form is just printing money. To create money from thin air, the Federal Reserve buys Treasury debt securities from a select group of banks called primary dealers. The primary dealers have a global base of customers, ranging from sovereign wealth funds, other central banks, pension funds and institutional investors to high-net-worth individuals. The dealers act as intermediaries between the Fed and the marketplace by underwriting Treasury auctions of new debt and making a market in existing debt.
When the Fed wants to reduce the money supply, they sell securities to the primary dealers. The securities go to the dealers and the money paid to the Fed simply disappears. Conversely, when the Fed wants to increase the money supply, they buy securities from the dealers. The Fed takes delivery of the securities and pays the dealers with freshly printed money. The money goes into the dealers’ bank accounts, where it can then support even more money creation by the banking system. This buying and selling of securities between the Fed and the primary dealers is the main form of open market operations. The usual purpose of open market operations is to control short- term interest rates, which the Fed typically does by buying or selling the shortest-maturity Treasury securities—instruments such as Treasury bills maturing in thirty days. But what happens when interest rates in the shortest maturities are already zero and the Fed wants to provide additional monetary “ease”? Instead of buying very short maturities, the Fed can buy Treasury notes with intermediate maturities of five, seven or ten years. The ten-year note in particular is the benchmark used to price mortgages and corporate debt. By buying intermediate-term debt, the Fed could provide lower interest rates for home buyers and corporate borrowers to hopefully stimulate more economic activity. At least, this was the conventional theory.
In a globalized world, however, exchange rates act like a water-slide to move the effect of interest rates around quickly. Quantitative easing could be used by the Fed not just to ease financial conditions in the United States but also in China. It was the perfect currency war weapon and the Fed knew it. Quantitative easing worked because of the yuan-dollar peg maintained by the People’s Bank of China. As the Fed printed more money in its QE programs, much of that money found its way to China in the form of trade surpluses or hot money inflows looking for higher profits than were available in the United States. Once the dollars got to China, they were soaked up by the central bank in exchange for newly printed yuan. The more money the Fed printed, the more money China had to print to maintain the peg. China’s policy of pegging the yuan to the dollar was based on the mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges. Now the Fed was printing with a vengeance.
There was one important difference between the United States and China. The United States was a slack economy with little chance of inflation in the short run. China was a booming economy and had bounced back nicely from the Panic of 2008. There was less excess capacity in China to absorb the new money without causing inflation. The money printing in China quickly led to higher prices there. China was now importing inflation from the United States through the exchange rate peg after previously having exported its deflation to the United States the same way.
While yuan revaluation was going slowly in late 2010 and early 2011, inflation in China took off and quickly passed 5 percent on an annualized basis. By refusing to revalue, China was getting inflation instead. The United States was happy either way, because revaluation and inflation both increased the costs of Chinese exports and made the United States more competitive. From June 2010 through January 2011, yuan revaluation had moved at about a 4 percent annualized rate and Chinese inflation was moving at a 5 percent annualized rate so the total increase in the Chinese cost structure by adding revaluation and inflation was 9 percent. Projected over several years, this meant that the dollar would decline over 20 percent relative to the yuan in terms of export prices. This was exactly what Senator Chuck Schumer and other critics in the United States had been calling for. China now had no good options. If it maintained the currency peg, the Fed would keep printing and inflation in China would get out of control. If China revalued, it might keep a lid on inflation, but its cost structure would go up when measured in other currencies. The Fed and the United States would win either way.
While revaluation and inflation might be economic equivalents when it came to increasing costs, there was one important difference. Revaluation could be controlled to some extent since the Chinese could direct the timing of each change in the pegged rate even if the Fed was forcing the overall direction. Inflation, on the other hand, was essentially uncontrolled. It could emerge in one sector such as food or fuel and quickly spread through supply chains in unpredictable ways. Inflation could have huge behavioral impacts and start to feed on itself in a self-fulfilling cycle as merchants and wholesalers raised prices in anticipation of price increases by others.
Inflation was one of the catalysts of the June 1989 Tiananmen Square protests, which ended in massacre. Conservative Chinese counted on a steady relationship between their currency and the dollar and a steady value for their massive holdings of U.S. Treasury debt, exactly as Europe had enjoyed in the early days of Bretton Woods. Now they were betrayed—the Fed was forcing their hand. Given the choice between uncontrolled inflation with unforeseen consequences and a controlled revaluation of the yuan, the Chinese moved steadily in the direction of revaluation beginning in June 2010, increasing dramatically by mid-2011.
The United States had won round one of the currency wars. Like a heavyweight boxing match between the United States and China, it was round one of what promised to be a fifteen-round fight. Both boxers were still standing; the United States had won the round on points, not with a knockout. The Fed was planted in the U.S. corner like a cut man ready to fix any damage. China had help in its corner too—from QE victims around the world. Soon the bell would toll to start round two.
When the principal combatants use their weapons in any war, noncombatants soon suffer collateral damage, and a currency war is no different. The inflation the United States had desperately sought not only found its way to China but also to emerging markets generally. Through a combination of trade surpluses and hot money flows seeking higher investment returns, inflation caused by U.S. money printing soon emerged in South Korea, Brazil, Indonesia, Thailand, Vietnam and elsewhere. Fed chairman Bernanke blithely adopted a “blame the victim” approach, saying that those countries had no one to blame but themselves because they’d refused to appreciate their currencies against the dollar in order to reduce their surpluses and slow down the hot money. In the anodyne language of central bankers, Bernanke said:
Policy makers in the emerging markets have a range of powerful . . . tools that they can use to manage their economies and prevent overheating, including exchange rate adjustment Resurgent demand in the emerging markets has contributed significantly to the sharp recent run-up in global commodity prices. More generally, the maintenance of undervalued currencies by some countries has contributed to a pattern of global spending that is unbalanced and unsustainable.
This ignored the fact that many of the commodities that residents of those countries were purchasing, such as wheat, corn, oil, soybeans, lumber, coffee and sugar, are priced on world, not local, markets. As consumers in specific markets bid up prices in response to Fed money printing, prices rose not only in those local markets but also worldwide.
Soon the effects of Fed money printing were felt not only in the relatively successful emerging markets of East Asia and Latin America, but also in the much poorer parts of Africa and the Middle East. When a factory worker lives on $12,000 per year, rising food prices are an inconvenience. When a peasant lives on $3,000 per year, rising food prices are the difference between eating and starving, between life and death. The civil unrest, riots and insurrection that erupted in Tunisia in early 2011 and quickly spread to Egypt, Jordan, Yemen, Morocco, Libya and beyond were as much a reaction to rising food and energy prices and lower standards of living as they were to dictatorships and lack of democracy. Countries in the Middle East strained their budgets to subsidize staples such as bread to mitigate the worst effects of this inflation. This converted the inflation problem into a fiscal problem, especially in Egypt, where tax collection became chaotic and revenues from tourism dried up in the aftermath of the Arab Spring revolutions. The situation become so dire that the G8, meeting in Deauville, France, in May 2011, hastily arranged a $20 billion pledge of new financial support to Egypt and Tunisia. Bernanke was already out of touch with the travails of average Americans; now he was increasingly out of touch with the world.
It remained to be seen whether the G20 could divert the United States from its runaway fiscal and monetary policies, which were flooding the world with dollars and causing global inflation in food and energy prices. For its part, the United States sought allies inside the G20 such as France and Brazil to apply pressure on the Chinese to revalue. The U.S. view was that everyone— Europe, North America and Latin America—would gain exports and growth if China revalued the yuan and increased domestic consumption. This may have been true in theory, but the U.S. strategy of flooding the world with dollars seemed to be causing great harm in the meantime. China and the United States were engaged in a global game of chicken, with China sticking to its export model and the United States trying to inflate away China’s export cost advantage. But inflation was not confined to China, and the whole world grew alarmed at the damage. The G20 was supposed to provide a forum to coordinate global economic policies, but it was starting to look more like a playground with two bullies daring everyone else to chose sides.
In the run-up to the G20 leaders’ summit in Seoul in November 2010, Geithner tried to paint China into a corner by articulating a percentage test for when trade surpluses became excessive and unsustainable from a global perspective. In general, any annual trade surplus in excess of 4 percent of GDP would be treated as a sign that the currency of the surplus country needed to be revalued in order to tilt the terms of trade away from the surplus country and toward deficit countries like the United States. This was something that used to happen automatically under the classical gold standard but now required central bank currency manipulation.
Geithner’s idea went nowhere. He had wanted to target China, yet, unfortunately for his thesis, Germany also became a target, because the German trade surplus was about as large as China’s when expressed as a percentage of GDP. By Geithner’s own metrics, the Germany currency, the euro, would also have to be revalued upward. This was the last thing Germany and the rest of Europe wanted, given the precarious nature of their economic recoveries, the structural weakness of their banking system and the importance of German exports to Europe’s job situation. Finding support in neither Europe nor Asia, Geithner quietly dropped the idea.
Instead of setting firm targets, the Seoul G20 leaders’ summit suggested the idea of “indicative guidelines” for determining when trade surpluses might be at unsustainable levels. The exact nature of these guidelines was left to a subsequent meeting of the finance ministers and central bank governors to work out. In February 2011, the ministers and governors met in Paris and agreed in principle on what factors might be included as “indicators,” but they did not yet agree on exactly what level of each indicator might be tolerated, or not, within the indicative guidelines. That quantification process was left for a subsequent meeting in April and the entire process was left up to the final approval of the G20 leaders themselves at the annual meeting, in Cannes in November 2011.
Meanwhile, the empowerment of the IMF as the watchdog of the G20 continued apace. In a March 2011 conference in Nanjing, China, attended by experts and economists, G20 president Nicolas Sarkozy said, with regard to balance of payments, “Greater supervision by the IMF appears indispensible.”
Saying that the G20 process moves forward at a glacial pace seems kind. Yet with twenty sovereign leaders and as many different agendas, it was not clear what the alternative would be if a global solution was to be achieved. This is the downside of Geithner’s theory of convening power. The absence of governance can be efficient if the people in the room are like-minded or if one party in the room has the ability to coerce the others, as had been true when the Fed confronted the fourteen families at the time of the LTCM bailout. When the assembled parties have widely divergent goals and different views on how to achieve those goals, the absence of leadership means that minute incremental change is the best that can be hoped for. By 2011 it appeared that the changes were so minute and so slow as to be no change at all.
The G20 was far from perfect as an institution, but it was all the world had. The G7 model seemed dead and the United Nations offered nothing comparable. The IMF was capable of good technical analysis; it was useful as a referee of whatever policies the G20 could agree on. But IMF governance was heavily weighted to the old trilateral model of North America, Japan and Western Europe, and its influence was resented in the emerging markets powerhouses such as China, India, Brazil and Indonesia. The IMF was useful; however, change would also be needed there to conform to new global realities.
In late 2008 and early 2009, the G20 was able to coordinate policy effectively because the members were united by fear. The collapse of capital markets, world trade, industrial output and employment had been so catastrophic as to force a consensus on bailouts, stimulus and new forms of regulation on banks.
By 2011, it appeared the storm had passed and the G20 members were back to their individual agendas—continued large surpluses for China and Germany and continued efforts by the United States to undermine the dollar to reverse those surpluses and help U.S. exports. Yet there was no Richard Nixon around to take preemptive action and no John Connally to knock heads. America had lost its clout. It would take another crisis to prompt unified action by the G20. Given the policy of U.S. money printing and its inflationary side effects around the world, it seemed the next crisis would not be long in coming.
That crisis arrived with a jolt near the city of Sendai, Japan, on the afternoon of March 11, 2011. A 9.0 earthquake followed quickly by a ten- meter-high tsunami devastated the northeast coastline of Japan, killing thousands, inundating entire towns and villages, and destroying infrastructure of every kind—ports, fishing fleets, farms, bridges, roads and communications. Within days the worst nuclear disaster since Chernobyl had commenced at a nuclear power plant near Sendai, with the meltdown of radioactive fuel rods in several reactors and the release of radiation in plumes affecting the general public. As the world wrestled with the aftermath, a new front arose in the currency wars. The Japanese yen suddenly surged to a record high against the dollar, bolstered by expectations of massive yen repatriation by Japanese investors to fund reconstruction. Japan held over $2 trillion in assets outside of the country, mostly in the United States, and over $850 billion of dollar-denominated reserves. Some portion of these would have to be sold in dollars, converted to yen and moved back to Japan to pay for rebuilding. This massive sell-dollars /buy-yen dynamic was behind the surge in the yen.
From the U.S. perspective, the rise in the yen relative to the dollar seemed to fit nicely into the U.S. goals, yet Japan wanted the opposite. The Japanese economy was facing a catastrophe, and a cheap yen would help promote Japanese exports and get the Japanese economy back on its feet. The magnitude of the catastrophe in Japan was just too great—for now the U.S. policy of a cheap dollar would have to take a backseat to the need for a cheap yen.
There was no denying the urgency of Japan’s need to cash out its dollar assets to fund its reconstruction; this was the force driving the yen higher. Only the force of coordinated central bank intervention would be powerful enough to push back against the flood of yen pouring back into Japan. The yen-dollar relationship was too specialized for G20 action, and there was no G20 meeting imminent anyway. The big three of the United States, Japan and the European Central Bank would address the problem themselves.
Under the banner of the G7, French finance minister Christine Lagarde placed a phone call to U.S. Treasury secretary Geithner on March 17, 2011, to initiate a coordinated assault on the yen. After consultations among the central bank heads responsible for the actual intervention and a briefing to President Obama, the attack on the yen was launched at the open of business in Japan on the morning of March 18, 2011. This attack consisted of massive dumping of yen by central banks and corresponding purchases of dollars, euros, Swiss francs and other currencies. The attack continued around the world and across time zones as European and New York markets opened. This central bank intervention was successful, and by late in the day on March 18 the yen had been pushed off its highs and was moving back into a more normal trading range against the dollar. Lagarde’s deft handling of the yen intervention enhanced her already strong reputation for crisis management earned during the Panic of 2008 and the first phase of the euro sovereign debt crisis in 2010. She was the near universal choice to replace the disgraced Dominique Strauss-Kahn as head of the IMF in June 2011.
If the G20 was like a massive army, the G7 had shown it could still play the role of special forces, acting quickly and stealthily to achieve a narrowly defined goal. The G7 had turned the tide at least temporarily. However, the natural force of yen repatriation to Japan had not gone away, nor had the speculators who anticipate and profit from such moves. For a while, it was back to the bad old days of the 1970s and 1980s as a small group of central banks fended off attacks from speculators and the fundamental forces of revaluation. In the larger scheme of things, Japan’s need for a weak yen was a setback to the U.S. plan for a weak dollar. The classic beggar-thy-neighbor problem of competitive devaluations had taken on a new face. Now, in addition to China, the United States and Europe all wanting to weaken their currencies, Japan, which had traditionally been willing to play along with
U.S. wishes for a stronger yen, found itself in the cheap-currency camp too. Not everyone could cheapen at once; the circle still could not be squared. Ultimately the dollar-yen struggle would be added to the dollar-yuan fight already on the G20 agenda as the world sought a global solution to its currency woes.
