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While many investors have their eyes on the G-20 Summit in November, this weekend’s gathering of G-20 finance ministers could prove to be the more significant event for markets.
If you take a look at recent history, I think you would agree.
In March 2009, when the financial crisis was at its peak, when uncertainty was at its greatest, the G-20 finance ministers met in a perceived “warm-up” for the broader G-20 Summit in the weeks following.
It just so happened that the U.S. stock market reversed from the depths of its deepest decline since the Great Depression that same week — the world’s most closely monitored gauge for the health of the U.S. economy jumped 25 percent in just 14 trading days.
The bounce in stocks took commodities and most global currencies with it. And with that came a recovery in global confidence and risk appetite.
The overall result was a sharp nine-month rally in global financial markets that persuaded the masses that “a sharp economic recovery and a return to normalcy” were under way.
Then …
In June 2010, the global economy was again on the precipice of disaster. Unsustainable sovereign debt problems in the euro zone had taken its currency — the world’s second most widely held — to the edge of a cliff, and the European banking system was not far behind it.
A potential destruction of the euro, the monetary union and the sovereign debt laden European banking system started sending up warning flares for economies around the world. Once again, liquidity started tightening up, putting the world’s financial system in jeopardy.
The world’s attention was squarely on the euro. As the euro moved lower, so did global stocks, commodities and higher risk currencies.
The decline in those markets destroyed confidence and threatened the global economy with another bout of recession.
AGAIN, the finance ministers convened for scheduled meetings over an early June weekend. And sure enough, the following Monday, June 7, the euro bottomed.
As the euro moved higher, global investor fear began to wane. Global markets bounced back and outlook for the world brightened.
Confidence was restored in financial markets.
Now, here we are with a THIRD meeting of G-20 finance ministers, also with a brewing crisis of confidence.
This time, it’s about the growing acts of protectionism — actions that are fracturing the geopolitical unity that has been critical in keeping the global economic crisis from boiling over into unabated depression.
The key spoiler: An escalating crisis in currencies.
Currency Wars
With the recent weakness in the dollar, most global currencies have been aggressively climbing in value.
In response, there has been a growing frequency of unilateral currency market intervention. In plain English, to protect their competitiveness in global trade, countries are battling each other to weaken their currencies.
Japan stepped in last month to weaken the yen with its biggest daily intervention on record. South Korea, Thailand, Singapore, Brazil and others have been consistently intervening to stem the tide of strength in their currencies.
While many perceive the catalyst for these actions to be the dollar and Fed policy, that’s not entirely the case. It all boils down to China.
Countries that are heavily reliant on exporting are less concerned about the value of their currencies relative to the dollar than they are relative to China’s currency … the yuan.
While its trade competitors are experiencing stronger currencies, China continues to keep a lid on the yuan — keeping it closely aligned with the dollar. That has created an increasingly growing competitive trade advantage for China.
That’s precisely why we’re seeing countries take matters into their own hands, with outright intervention to weaken their currencies. And given this environment, global officials are very concerned that a contagion of protectionism could quickly send the world back toward the edge of the cliff.
So, with the G-20 finance ministers back in session this weekend, will we see a market response?
Given the recent history, I see two ways they could act to change the tide:
Action #1: Convince China to revalue its currency … a one-off revaluation.
It would be a move that would go a long way toward rebalancing global economies, a key ingredient in allowing the world to find a sustainable path of growth. That would also reverse global central banks’ bias toward more QE — a stabilizing force. And it would create a more competitive trade environment for Asian exporters — a stabilizing force. But a China revaluation is very unlikely to happen.
Action #2: A coordinated intervention by G-4 countries to weaken the yen against the dollar.
This would reinforce global unity. And it would weaken most currencies around the world relative the Chinese yuan, because it would strengthen the dollar, to which the yuan continues to trade very tightly with.
It wouldn’t change the biggest problem with the yuan … its relationship with the dollar. But it would quell the rising threat of global competitive currency devaluations among its global trading competitors, a dangerous and divisive game.
Regards,
Bryan
