The G8: In Search of a Happy Ending

Once upon a time, eight great kingdoms decided to join forces in the battle against the global recession in 1973. They called themselves the “Great 8” or G8 – presumably using the word “great” to signify their status as world leaders. Dubbed as the “most industrialized” nations, the G8 comprises France (who founded the conference in 1975), Germany, Canada, Italy, Japan, Russia, the United Kingdom, and of course, the United States (would the US ever keep itself out of anything “great”?). Now that the world is in the throes of the worst post-war global recession, how will the G8 fight its way out?

Recently, France and the UK have been making cat calls to expand the G8. In recent meetings, the G8 has had some guests members, most notably China, Brazil and India. Yes, I know what you’re thinking… that’s the BRIC group! Remember that little somethin‘ I did a few weeks before about their little forum?

Not too long ago, China urged the rest of the nations to consider using the International Monetary Fund’s Special Drawing Rights or SDRs as a super-sovereign currency. There were rumors that Chinese President Hu Jintao would propose this to the summit and perhaps even suggest that the yuan be added to the SDRs’ basket of currencies. Russian Finance Minister Alexai Kudrin has even gone as far as suggesting that China’s yuan could become a world reserve currency.

“The dollar system or the system based on the dollar and euro have shown that they are flawed. But I am a realist and I understand that today there is no alternative to the dollar or the European currency,” Russian President Dmitry Medvedev said in an interview. “There should be more reserve currencies. So we consider that we need to think about the creation of regional reserve currencies.” Such strong statements from the BRIC kids!

Both these countries certainly aren’t standing idly by as their currency reserves are threatened. Russia has already reduced its USD reserves to 41.5% from 45%. China, on the other hand, is finding ways to diversify its reserves out from USD. The problem is that there isn’t really any other USD alternative, so moves like this will take time to materialize. Still, something like this can’t be taken lightly…especially since China and Russia are members of the both the G8 and the BRIC.

Let me put this in perspective. The world has an estimated amount of 6.898 trillion in USD reserves, around 63% of the world’s currency reserves. The BRIC holds approximately 2.465 trillion USD of this amount. The BRIC’s combined gross domestic product however, represents only fifteen percent of the world economy yet they got their hands on almost forty percent of the world’s USD reserves… With this sort of imbalance, it just makes me wonder how long it would take for the USD to crack.

But so far, the topic of anti-dollar diversification hasn’t been brought up yet. Could they bring the topic up before the summit is over?

According to a draft communiqué (that means advance statement for simpletons like us) of the ongoing G8 summit, the member countries will be talking about agricultural investments in developing countries and fighting trade protectionism.

What may be of more significance to forex markets is the G8’s discussion of their exit strategies. In an effort to put a lid on the economic recession, debt has substantially increased due to the implementation of economic stimulus plans. With recent economic data showing some improvements, the question of when to “exit” has been brought up, most recently during the last G20 meeting.

Now what will happen to member states’ currencies if they extend the duration of their economic stimulus plans? Well, one possible scenario is a weakening of the local currency. For example, the GBP could weaken if the UK government decides to expand its quantitative easing program. Recall that the S&P has already downgraded its outlook on the UK and further easing would raise concerns on the UK’s ability to honor its debt obligations. On the other hand, the UK government may decide to just take a “wait-and-see” approach, to see the full effects of their program. If the economy shows improvement, then maybe a delay in exit strategies may be the best move to make.

No matter what angle you look at it, this recession certainly isn’t a fairy tale. A “happily ever after” may be a long time coming as jobs are still being lost, houses are being repossessed and companies are going bankrupt. An “unfairy tale” is what this is… and we’re all just waiting for when we will see signs of a happy ending. Until then, good luck and be safe in the markets!