Preliminary Thoughts about the Upcoming G7 Meeting

There have been suggestions that the G20 becomes the basis for a new governance structure of the IMF. If if this does not come to pass, it is clear the the G7 has been downgraded to a caucus within that larger group. Canada heads up this year and its influence is greater in the G7 than in the G20 so it is little wonder that it is trying to build an separate agenda for the G7. With Canada at the helm, it may postpone an real identity crisis for the G7 until next year, when it appears France will host both the G7 and G20.

France's Sarkozy has been a vocal advocate of expanding the G7/8. In addition, he has been among the leading voices in calling for a new Bretton Woods. Although Gillian Tett, the prize winning economist at the Financial Times argued last week that we should take such calls seriously, it seems doubtful that there will or really can be much progress in that direction.

First, most observers miss how the shift to toward the G20 is not really a dilution of US power and in fact, helps it achieve other policy objectives. One objective might be how to dilute Russia's influence on the G8, given its behavior over the past 2 years (and recent news that it sought Chinese cooperation to squeeze the US by dumping Agencies) without a confrontation that would be entailed to force it to exit. Answer: enlarge the group. Another US objective that might be met by the increased role for the G20 is that it prevents or at least minimizes the risk of China forming their own parallel forum.

The calls for a new Bretton Woods sound hollow. Bretton Woods was made possible by the large asymmetries that in power at the end of WWII. Bretton Woods in effect institutionalized those asymmetries and in many ways proved to inflexible, not just to the US quest for guns and butter, but for the recoveries of Europe and Japan. With questions having been raised about the structural challenges the US faces and if it is not in some kind of non-cyclical decline, and China and other developing countries on the march, there is really little incentive to institutionalize current power relationships. The US is not in a position to dictate a new Bretton Woods, but nor is anyone else.

Most pressing for the G7 is to coordinate their policy response and the reform of the financial sector and minimize the risks of regulatory arbitrage. The new US initiatives may be the subject of much discussion. The UK, Germany and France appear sympathetic to a Tobin-like tax to ostensibly discourage "excessive" index , but the IMF and the US are not and the G7 may not be the most effective forum for this discussion.

As recently as last week, French officials were complaining about the euro's strength. Nevertheless, the recent slide in the euro--nearly 5% off the mid-Jan high and almost 9% off the late Nov high will remove the saliency of their complaints. Nor is the threat of BOJ intervention to weaken the yen very real. The BOJ reported earlier today that its measure of the trade weighted yen hit a five month low in January.

China's currency policy will likely come under more pointed criticism. With exports rising and inflation pressures mounting, the G7 apparently growing more frustrated with the peg. Yet in truth, many officials do recognize that China's competitive strength extends far beyond the value of the yuan. And from China's point of view, as Japan has found, Europe and the US have a near insatiable appetite for others to appreciate their currencies.