The G7 industrial powers, under pressure to address a decline of the yen, warned investors that they could get burned betting in one direction when Japan's economy was continuing to strengthen.
The Group of Seven also repeated appeals to China to relax the state grip on the yuan's exchange rate by calling for more currency flexibility and citing the world's fourth-biggest economy by name. And they commissioned a report on hedge funds.
The main innovation at a meeting dominated by currencies and market risk came in a declaration of confidence in the recovery of Japan's economy and warnings from top officials against the carry trade--an investment play that compounds yen weakness.
In a statement issued after talks in Essen, Germany, the G7 said the U.S. economy was solid and Europe rebounding broadly.
"Recovery on Track"
"Japan's recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants and will be incorporated in their assessments of risks," it said.
The yen recently hit a 21-year low on a trade-weighted basis and has shed four times as much versus the euro in the past year than versus the dollar, sparking concern that European exporters will suffer disproportionately in competition on world markets.
European Central Bank President Jean-Claude Trichet added a layer of warning against the practice of borrowing vast amounts in low-yield currencies such as the yen to reinvest for a profit elsewhere--carry trades, as they are called.
"We want the markets to be aware of the risks of one-way bets, in particular on the foreign exchange market," Trichet told a news conference, adding that he was not talking only about yen-based carry trades.
"One-way bets in the present circumstances would not be, it seems to us, appropriate. We want the markets to be aware of the risks they contain," he said.
Japanese Finance Minister Koji Omi appeared to be singing from the same song book. "This means that G7 countries think that markets, particularly forex markets, should recognize the risk of moving in one direction too heavily," he said.
"I think we have come to the appropriate conclusion."
Effect on Markets Unclear
How effective the warnings would be was far from clear.
Marco Annunziata, chief economist at UniCredit investment bank, said the G7 was clearly trying but still unlikely to reverse market trends.
"It's nice of them to send a warning on one-way bets ... but it still sounds like cheap talk," he said, adding that markets were well aware of Japan's economic recovery story but also that the country had yet to nail the coffin on a decade of deflation.
Moreover, he added, the G7 had also said the global economy was doing nicely. "That's a great backdrop for putting on even more carry trades," he said.
International Monetary Fund chief Rodrigo Rato, also at the G7 talks, said he expected another year of global economic growth of around 5 percent in 2007.
The Essen talks involved finance ministers and central bank bosses from the G7--the United States, Japan, Germany, France, Italy, Britain and Canada--and their counterparts from China, whose economy is now bigger than many in the rich nations club.
The G7 renewed calls for efforts to strike a deal in stalled free-trade talks.
As concern over global warming moves up the global agenda, their statement endorsed the pursuit of energy efficiency and said alternative energy sources were increasingly important.
Greater Flexibility in Currencies
U.S. Treasury Secretary Henry Paulson had dismissed Europe's yen complaints and was among the only ones who refused to be drawn on carry trades when pressed by journalists in Essen.
He said the yuan rather than the yen was the problem because the Chinese currency was controlled by the Chinese authorities and remained too weak.
The G7 statement repeated a call for greater flexibility in currencies and said this was especially the case for China.
"In emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur," the G7 communiqué said.
China, given red-carpet treatment by G7 president Germany and invited for the first time to take part in the strategic part of G7 discussions, issued a statement of its own but said nothing of the renewed appeal on the yuan.
"We continue to strengthen macroeconomic adjustments," said Finance Minister Jin Renqing, who was unhappy with the hotel put on for G7 VIPs in Essen and checked into another one.
Concern Aboout Hedge Funds
The other target of G7 attention was the burgeoning hedge fund industry, on which the ministers commissioned a report by the so-called Financial Stability Forum, a panel of top-level officials set up to monitor issues of global market solidity.
"Given the strong growth of the hedge fund industry and the instruments they trade, we need to be vigilant," the statement from the G7 said.
Germany lobbied hard for a discussion of potential systemic risks to the stability of the world capitalist system from hedge funds, which are less regulated than many other funds, though the G7 said the funds had also improved market efficiency.
In addition to special treatment for China, G7 host Germany invited representatives of other major emerging market economies to Essen, from Brazil, India, Mexico, Brazil and South Africa.
German Finance Minister Peer Steinbrueck said on Friday he would like to see the G7, founded in the 1970s, embrace key emerging economies.
As the finance chiefs negotiated in a well-guarded building, anti-globalization protesters gathered in the city center to voice their disapproval. Police said about 700 of them had gathered in a damp and chilly downtown Essen.