G20 Remains Divided

Last week, leaders from the G20 nations discussed their concerns regarding current account imbalances. That’s it.

g20-boring.png*crickets chirping*

Yep, that’s right. They merely voiced out their concerns but didn’t come up with anything conclusive. No specific current account targets were set, only a set of guidelines for measuring the balances were determined. However, the full details of these guidelines won’t be determined until next year.

The good news is that they all agreed to move towards a market-determined exchange rate system based on countries’ economic performances. There’s one problem though – each nation can interpret it differently.

Let’s take a look at the different point-of-views, starting with the U.S.

The U.S. believes China has been keeping the value of its currency artificially low, which has been giving them a huge advantage in trade. Remember, whenever a foreign company wishes to import goods from China, that company must first exchange its local currency to the Chinese yuan. This means that the lower the yuan is, the cheaper it is for foreigners to purchase China’s products.

Meanwhile, China is concerned about the U.S.’s very resolute stance towards quantitative easing. While quantitative easing may help stimulate the U.S. economy, it can also weaken the dollar, which is just another form of competitive devaluation. Classic case of pot calling the kettle black, eh?

The U.S. quantitative easing program can also cause a huge inflow of capital from investors in the U.S. to emerging economies (e.g. Brazil, Thailand, South Korea, etc.), which could stoke inflation and currency appreciation. Because of this, emerging economies argue that it only makes sense for them to implement controls to prevent too much foreign investment in their country.

You might be wondering, if it was so darn uneventful, why did we see the euro tumble to a six-week low against the dollar, and AUD/USD and USD/CAD scurry away from parity at the wake of the meeting?

Well, in case you were too busy playing Angry Birds, risk aversion was the name of the game thanks to renewed concerns on Europe’s sovereign debt and a possible rate hike from China following stronger-than-expected inflation figures.

But looking ahead, a few economic hotshots think that once the spotlight moves away from Europe, the inconclusive G20 meeting could send the dollar into pip-deeps. With the U.S.’s QE2 making the dollar an ideal funding currency for carry trades, and China seemingly intent on keeping an easy monetary policy in place, we could see a strong demand for higher-yielding currencies when market sentiment picks up.

You may want to keep an ear out for any comments from major central banks though. Word on the street is that, some of them (cough RBA, cough BOC) are already beginning to worry about the negative effects of their strong currencies on the domestic economy. Yikes!