G7 Flip-Flop Roils the Currency War

This week's G-7 meeting this week isn't off to a good start. In an effort to stave off concerns about unilateral moves in a renewed currency war, the delegates managed to strike a blow for and against the goals of a new Japanese government. The only result has been more volatility and uncertainty about what will happen going forward.

In late December, Shinzo Abe returned as Japan's Prime Minister on a platform of loosened monetary policy, a relatively large package of stimulus spending and a doubled target for inflation. All of the efforts strongly point towards a weakening yen to support exports as Japan suffers through entrenched trade imbalances.

Up until this weekend, the yen drifted significantly downward against the dollar and euro and hovered near three year lows. Since the beginning of 2013, the yen lost about 7% of its value against the dollar and about 8.5% against the euro in a somewhat orderly fashion.

The trend clearly upset a number of officials. Amidst publicly aired concerns from many nations. Last week, France publicly called for intervention in exchange rates by setting a medium-term target for the euro out of concern that it was becoming unnaturally strong. The ECB and officials in Berline rebuked the claim, but the damage was already done.

Then the G7 decided seemed to think that everyone needed to calm down by collectively chiming in with a joint statement:

"We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will continue to consult closely on exchange markets and cooperate as appropriate."

Their goal was relatively benign: They want the free market to determine currency values, as it supposedly always has amongst the nations. They didn't spell out any consequences for Japan or explicitly call them out on their plans.

Unfortunately, their mild commitment to the status quo completely backfired as an official representing the G7 stated that the earlier statement should be “signaling concern about excess moves in the yen” and that “Japan will be in the spotlight at the G20 meeting in Moscow this weekend.”

Surprise! The far more important and and influential G20 is going to team up against Japan's currency manipulation.

The exchange rate between the US Dollar and Yen immediately shifted over 1% as volatility spiked and traders freaked out. The part of the G7 statement about “excessive volatility and disorderly movements” held no weight in the free market.

So did this official go rogue by expressing concern about and Japan's policies and potential international intervention? Was the original G7 statement too tame or too lenient on Japan?

Really it doesn't matter. The market, as they say, is always right and it is clearly banking on national and international currency intervention with the massive and sudden exchange rate correction.

Until the G20 meeting concludes and we know what to expect, there will be no reprieve and no treaty. Government officials are manning their battle stations at the printing presses and press conferences. We're at war.