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Busch: Currency Intervention Back In Style

With the dramatic plunge in the British pound and the dramatic rise of the Japanese yen & Swiss Franc, the rumblings from Tokyo to Zurich to London are all pointing in the direction of action.

The party started yesterday during the Senate confirmation hearings for US Treasury Secretary nominee Tim Geithner. First, Paul Volcker stated that, "We are in the midst of the mother of all financial crises. Risks exist of undermining confidence in the US dollar."

Then Geithner said, "I deeply share and completely believe (in) ... China's importance to the global economy and our economic and financial future, and I think we have to get that right. Our interests as a nation lie in trying to make sure China manages its transition as effectively as possible, with least potential damage and risk to the global economy. It is going to require a very substantial sustained engagement. ... I believe that it is in the interests of the global economy, not just our interests, that our major trading partners move over time to a more flexible exchange rate system."

" I do believe it is a significant issue. As I said earlier, I believe it is important for the United States and the global economy that our major trading partners operate with a flexible exchange rate system and that market forces determine the level of those exchange rates. I think that's very important, and - when I have some time to think through how best to achieve that objective look forward to a chance to work with you and your colleagues on the committee on how we do that."

There are two important components to this statement.

One, he's putting our trading partners on notice that the US will not change its approach to currency management and that the US trade partners shouldn't manipulate their currencies either. Two, Geithner has not be aware of the thrust of the US Treasury's policy of engagement with China since Hank Paulson took over.

Also, we had the Swiss National Bank Swiss National Bank Vice-President Philipp Hildebrand say that policy makers are prepared to intervene in currency markets at fixed exchange rates if necessary to prevent a “renewed appreciation” of the franc according to Bloomberg. “With short-term rates of practically zero, the SNB can’t prevent a further appreciation in the Swiss franc through a rate cut. The SNB is able to sell unlimited Swiss francs versus another currency. In an extreme case, it can commit itself at the same time to buying unlimited currencies at a fixed-exchange rate.”

Overnight, Japanese Finance Minister Shoichi Nakagawa warned against rapid moves in foreign exchange rates and said intervention was something to bear in mind all the time, although he declined to comment on the possibility of Tokyo taking such a step according to Reuters. "Rapid moves are not good, so I am watching the moves carefully," Nakagawa said after the yen hit a 13-year high against the dollar. Asked about the possibility of Tokyo intervening in the currency market, Nakagawa said: "I should not comment on it. But we should always be thinking about doing what may be necessary."

Lastly, French Economy Minister Christine Lagarde said she wished to see the Bank of England do something more to support the pound, perhaps because BoE chief Mervyn King has not shied away from highlighting that British exporters benefit from its weakness. "I note the Bank of England is doing what it can, but its monetary policy and management of rates ... have not been particularly efficient for supporting the currency a bit more. It would be in their interest to support it a bit."

Mysteriously today, we had a G7 "source" leak to Reuters that the fall in value of the British pound is a problem for mainland Europe and will be added to regular talks on exchange rate issues when G7 finance ministers meet in February. The source said that the situation on currency markets in general had not reached crisis levels and that there was no need yet for verbal intervention to try to influence exchange rates. "The pound is depreciating. It is obviously a problem for Europe. It's an economic problem. For the moment this does not affect us financially. Normally, we talk about the dollar, yen, and the euro but this time we'll be talking about the pound as well."

Given how most finance ministers must be feeling emasculated during this credit crisis, they must feel that they can act in the currency markets and have an impact. Throughout history, the tale of a collapsed economy being temporarily reinvigorated by a currency depreciation is well known. The twist this time is that everyone including the Chinese are experiencing a recession. The British were the first to go down this path, but it has not gone unnoticed. This will make the currency markets even more unstable and will generate tremendous focus on the Valentines Day G7 meeting.

This has the potential to be a 3-D horror show with official verbal jousting, but stealth currency action by disgruntled countries.

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Andrew Busch

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Andrew B. Busch here

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