At last week’s G8 meeting in Washington, it was expected that currencies would be a hot topic of discussion.  With the Dollar retreating to record lows on a daily basis, the failure of China to allow the Yuan to appreciate, the Japanese Yen’s continued weakness despite its strong economy, and the recent parity of the Canadian Dollar and USD, there are certainly plenty of forex phenomena that deserve attention.  However, it is the Euro/USD relationship that probably received the most scrutiny, as the biggest contingent of the G8 uses the Euro.

European politicians and bureaucrats have spent the last few months arguing with America-as well as amongst themselves-over the declining Dollar.  The consensus is certainly that the Dollar is harming the European economies; as one German Minister phrased it, the “pain threshold” has been crossed.  At the same time, it is clear that a relatively weak Dollar is probably in the best interest of global economic stability, since the US current account and financial account imbalances can only be solved by changes in exchange rates.  Thus, there is a growing divide between European politicians, who tend to think in provincial terms, and the European Central Bank, which is more focused on the Big Picture.  The new President of France, for example, has been quite vocal in lamenting the appreciation of the Euro, even going so far as to demand the ECB step in.  Jean Claude Trichet, president of the ECB, responded by calling on European politicians to be circumspect in their comments on the Euro.

However, since Central Banks do not participate in G8 conferences, you can bet that politicians hounded Hank Paulson, US Secretary of the Treasury, on the declining Dollar.  Some analysts have even speculated that ‘intervention’ would enter into the discussions. In fact, the US has not intervened in forex markets since 1994, when Europe and American worked in tandem to prop up a then-ailing Dollar.  After a couple months, however, the plan was abandoned due to mixed results.  Is it possible that the US, confronted with the same situation, will once again attempt intervention?

The answer is “not likely.”  First, the Europeans are not even united in their position on the USD/Euro exchange rate.  Secretly, they would probably all prefer a stronger Dollar, but in public, only a handful have called for intervention.  Second, short of fixing the exchange rate (which would require the US to borrow money), it is very difficult for a government/central bank to control its currency.  Recent intervention by South Korea and Japan, as well as America’s efforts in 1994, ended in failure. Finally, there is the issue of China, which does control its currency.  The US would surely appear hypocritical if it intervened on behalf of the Dollar while simultaneously encouraging China to float the Yuan.  Thus, while certain US economic concessions may result of the G8 conference, a controlled appreciation of the Dollar will not likely be one of them.