G7 Silence on The Dollar May Be An Invitation to Sell


Already at an all-time low against the euro, the dollar looks set to plumb new depths this week after Group of Seven finance chiefs ended a weekend meeting without offering verbal support for the U.S. currency.

While the G7 did urge China to speed up appreciation of the yuan, its failure to address dollar weakness, notably against the euro, suggested traders need not fear any coordinated official efforts to prop up the greenback.

"The G7's statement effectively gives a green light to continue selling the dollar," said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon.

He said the euro is likely to break through its record high above $1.43 and soon make a run at $1.4550, which corresponds with the German mark's all-time high against the dollar.

"That has certainly come into speculators' crosshairs," he said.

After shedding 8 percent last year, the dollar has fallen by another 7 percent in 2007, mostly on fears that the Federal Reserve will cut interest rates further to stave off recession caused by a U.S housing slump and global credit crunch.

Traders responded by pushing the euro to a record high of $1.4319 and the greenback to its lowest level against a basket of currencies since the free-floating exchange rate regime was set up in the 1970s.

That led some European countries to complain the strong euro risked hurting exports and the euro zone economy, and to call on the G7 finance ministers and central bank governors.

Instead, they got mostly a repeat of the G7's stock language on currencies, including warnings that excessive volatility is undesirable for economic growth.

Analysts said the G7's silence on the dollar was largely expected, since Washington sees a weaker currency as a way to boost exports and thereby reduce its massive current account deficit. Indeed, the shortfall, while still large, has receded from more than 6 percent of gross domestic product in 2006 to 5.5 percent in the first six months of 2007.

That leaves traders to refocus this week on all the reasons to dump the dollar, including a growth slowdown and rising fears of the inflationary effects of oil at $90 a barrel.

"There's acknowledgment that the fundamentals in the U.S. economy aren't up to scratch at the moment, and in that regard the dollar isn't in the clear," said Phyllis Papadavid, currency strategist at Societe Generale in London.

Investor risk appetites, which took a hit last week amid a flurry of subpar corporate earnings reports and a swoon in the U.S. stock market, were likely to suffer again this week.

Strategists at RBC Capital Markets said that sets the dollar up for losses against the low-yielding Japanese currency, which gains when investors unwind carry trades that finance purchases of high-yield assets with cheaply borrowed yen.

The yen hit a three-week high on Friday at 114.52 yen per dollar.

Weighing in on the Yuan

More surprising was the G7's call for China to let the yuan appreciate more quickly.

That was slightly stronger than past references to the need for China to adopt a flexible exchange rate to help resolve the global imbalances -- code for the mismatch between surplus countries like China and excessive spenders like the United States.

In a note to clients, Goldman Sachs currency strategists said this, coupled with a focus on Chinese inflation -- "presumably to highlight that a stronger currency is in China's interest" -- should spark more yuan appreciation.

Analysts said the result may be near-term gains for the Japanese yen, which is often used as a proxy for the tightly controlled yuan.

China revalued its currency in 2005, but it remains tightly controlled. And while it has gained about 4 percent against the dollar this year, it's lost about the same amount against the euro.

"This brings the Europeans closer to the U.S. position on China, but I don't think it changes China's approach to liberalizing their currency," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Connecticut.

So far, that approach has called for a gradual appreciation as part of a much broader package of financial and structural reforms.

Wu Xiaoling, deputy governor of the People's Bank of China, reiterated as much in Washington over the weekend, saying that exchange rate adjustments without broader reforms aimed at increasing domestic demand will hamper Chinese and global growth.

"The bigger issue is that the G7 looks increasingly irrelevant, particularly on guiding exchange rates, when the bulk of the money is in the hands of emerging economies," Gilmore said.

Indeed, it is countries such as China, Russia and the Middle East oil producers who account for the lion's share of global foreign exchange reserves of $5.7 trillion, according to International Monetary Fund estimates.

"There's been a real shift in power," Gilmore said, "and the G7 has to bring the emerging world into a broader coalition of economic powers to really address cross-border currency issues."