A Note by the Director (Ditchley 2000/11)
17-19 November 2000
Over the weekend of 17-19 November we looked at the three main world currencies – the dollar, the euro and the yen – their performance, prospects and interrelationship. In the time available, and given the inevitable difference in analysis in some important respects, our policy conclusions were not always unanimous. But the exercise threw up a number of interesting points, not least proposals for future Ditchley conferences.
Unsurprisingly our discussions revealed that the dollar-euro-yen relationship could not be represented by an equilateral triangle. The dollar was of greater importance to the yen and the euro than they were to each other. We spent some time exploring the reasons for the dollar’s current pre-eminence on the world currency markets and as a store of wealth. Although not unanimous, there was a broad consensus that the wide-scale introduction of information technology in the US had led to a large increase in overall labour productivity and the return on dollar investments had been higher than in the euro or yen economies. Very large capital inflows, particularly from the euro area had also contributed to a steep appreciation of the dollar vis-à-vis the euro. To this could be added factors such as the higher level of entrepreneurial activity in the USA a greater cultural acceptance of risk and high labour mobility. Some argued that this was not a wholly convincing explanation part of which had to lie in the dynamics of financial markets which tended to exaggerate either good or bad news. But overall the “supply-siders” were in the majority.
We returned time and again to the difficult question of the large US current account deficit, variously estimated at 4 or 500 bn USD. The question was posed as to whether the current, or even a growing level of deficit at the present dollar exchange rate could be sustainable. There was a near unanimous view that this level of deficit was not sustainable over the longer term. Opinions were however, divided both over when such a correction might occur and whether it would be abrupt or slow – a hard or a soft landing. The optimists saw a slow correction as attainable and some argued that a current account deficit, albeit at a reduced level, could be sustained by the US economy indefinitely. There were also references to the Triffin Dilemma in support of the current account deficit as providing the necessary international liquidity. But the role of sterling in the 19th Century seemed to show that the UK had provided international liquidity while running a current account surplus. International capital had been supplied by UK direct foreign investment. At present, however, the USA was a recipient of large capital transfers.
The pessimists were less sanguine. The markets might ignore fundamentals and move very rapidly mainly on the basis of changed perceptions. Exogenous shocks could change the picture. Argentina and the oil price rise were examples of potential shocks, a crisis over Taiwan or a break-down of order in the Middle East were others. The optimists remained relatively unmoved. The remarkable drop in inflation in most major economies, budgetary surpluses in the USA and the resilience shown so far in financial markets in adapting, without panic, to considerable adjustments in equity prices, were all reassuring factors. The question was eventually posed as to whether the character of individual analysts was perhaps as important a factor in reaching their conclusions as the technical arguments they advanced.
In looking at policy responses in relation to the dollar there was agreement that an adjustment to the dollar’s real exchange rate in relation to the euro should occur through a fall in the dollar’s nominal exchange rate and not through an adjustment in US and euro-zone relative price levels. There was also agreement that a big fall in the USA’s budget surplus would aggravate global macroeconomic imbalances. One participant commented, however, that statistics on global balances were notoriously unreliable. An apparent $300 bn discrepancy now existed on the world current account. A number of ways of helping to correct the dollar’s present valuation were considered. Interest rate stimulated corrections raised little enthusiasm. The general view was that they could cause real difficulties for the yen, although less for the euro. Foreign exchange intervention appeared possible given the large dollar holdings in the Euro-zone, but views were mixed on the advantages of such a course. Most of us favoured supply-side measures to help close the productivity gap between the dollar and the euro and to increase the rate of return on investments in the euro-zone. If there was a less than unanimous view on the right way to tackle the US current account deficit, there was near unanimity that a large fiscal stimulus, either through deep tax cuts or public expenditure programmes of the sort favoured by the two Presidential candidates, were undesirable. The only comfort offered on this point was that the current electoral impasse, when resolved, would probably inhibit major policy initiatives by a new Administration.
In looking at the current value of the yen we rehearsed the various causes of the present difficulties facing Japanese policy makers. External pressures to expand the Japanese economy which led to the Plaza accord, followed by mistakes in monetary policy had resulted in the collapse of asset prices in 1991. Subsequent reform programmes had foundered on public resistance and the unwillingness or inability of the political system to take and implement the measures that were clearly necessary. The present position in terms of value in relation to the dollar was, it was argued, based on a current account surplus coupled with increasing foreign direct investment in Japan and low capital outflows. The main foreign exchange relationship for the yen was with the dollar. The euro was much less significant.
We asked ourselves whether the strong yen was a disadvantage for Japan and if so what might be done about it. We noted that the strong yen had relatively less impact than in the past since only some 10% of current economic activity was concerned with imports and exports. We went on to ask ourselves the heretical question whether in economic or political terms the present situation in Japan was of significance for the rest of the world. Most of us quickly concluded, notwithstanding econometric models which appeared to show that sustained growth of 1% per annum in the Japanese economy had little effect on OECD countries and only modest effects on other Asian economies, that Japan mattered a great deal. As the second largest economy in the world it had played an important part in helping to resolve the Asian financial crisis, it was a major investor outside Japan, had been a source of technology and management transfer and could well surprise the rest of the world again with technological innovation in the telecoms and other sectors.
We examined the policy options open to the Japanese authorities. There were some contradictory signs on the monetary policy front with the ending of the zero interest rate policy in August. On the fiscal side a number of suggestions were made including greater transparency which might help increase confidence in policy making. On balance we did not think it likely that an attempt would be made to restructure the public finances until a recovery began and this might take as long as three years. But even then pessimism was expressed as to whether the political will existed to take the right, even if unpopular, decisions. A new generation of politicians committed to reform did not yet appear ready to take over. Interest groups, in particular in the countryside, still exerted disproportionate influence. Although there were some signs that political change was gradually beginning, the pace and depth were still in doubt.
In looking at the euro-zone we first examined the fundamentals to see to what degree structural change was under way. We were informed that in both Germany and France there were signs of accelerating change since the introduction of the euro in 1999. In both countries, and in others in the EU, a programme of structural adjustment was now in train. Examples in Germany included agreement on tax reform, possible agreement on pension reforms by 2002, a balanced budget by 2006 and agreement on the Lisbon agenda. In France the level of Merger and Acquisition activity had increased dramatically, half a million new jobs had been created and peer pressure as a result of EU benchmarking practices was helping to introduce best practice. The key question to emerge was the degree to which the European social systems could remain relatively unchanged if structural reform, including labour mobility, was to be effective.
We looked at unfinished business in Europe and identified a proper level of funding for pensions in EU countries as a challenge. We considered the public and private routes for such funding and speculated that a change in the age of retirement might be necessary. Australia, for example, no longer had a formal retirement age.
Other pressures for change were the commitments stemming from the Lisbon agreement on structural reform and the benchmarking in various sectors arising from peer group pressures. Gas and electricity liberalisation would also help. But most of all the unification of financial markets in Europe was now a real possibility by 2005. Overall the majority view, based more, however, on feeling and anecdotal evidence than hard analysis, was that the decline of the Euro against the dollar and the yen was reaching its end and that future moves were likely to be towards a stronger euro. We recalled that price stability was the first priority of the ECB under the Maastricht Treaty, and in this regard the Euro had been a success. And, added one participant, the variation in the Dollar/Euro exchange rate was well within the historical cyclical variations in the Dollar/DM rate.
Those who took a more sceptical view of the euro argued that globalisation rather than the euro had been responsible for the structural reform in Europe. If the currency was such a success why did the ECB need to intervene in the foreign exchange markets to support it? On the other hand the euro long bond market had achieved considerable success which seemed to indicate a good level of confidence by investors in the longer term prospects of the euro. But, warned the traders, look out for the large number of investors who were long on euros at the moment and who might sell their holdings as soon as the euro/dollar exchange rate improved for the euro.
As part of the wider picture we looked at the sterling/euro relationship. Although one participant complained that instability in the euro had been exported to sterling, overall we thought that the pound was likely to fall relative to the euro. And although some sought answers as to when the UK would join EMU and what the effect had been of the negative vote in the Danish referendum, no clear replies were given. There was no great sense, however, that the UK would join EMU soon.
This report reflects the Director’s personal impressions of the conference. No participant is in any way committed to its content or expression.
Chairman : The Rt Hon The Lord Brittan of Spennithorne QC
Vice-Chairman, UBS Warburg.AUSTRALIA
Dr John Nieuwenhuysen
Chief Executive, Committee for Economic Development of Australia. CANADA
Mr Malcolm Knight
Senior Deputy Governor, Bank of Canada.
Mr John D McNeil
Director and Chairman of Executive Committee, Sun Life Assurance Company of Canada.
Mr Grant L Reuber OC FRSC
Senior Adviser and Director, Sussex Circle; President, Canadian Ditchley Foundation.
Mr William B P Robson
Director of Research, C D Howe Institute. EBRD
M Jean Lemierre
President, European Bank for Reconstruction and Development. ECB
Mr Vitor Gaspar
Director General, Research, European Central Bank. FRANCE
M Benoît Coeuré
Economic Adviser to the Director of the Treasury, Ministry of Economy and Finance.
M Philippe Lagayette OLH
Chairman, J P Morgan & Cie SA, Paris. GERMANY
Professor Clemens Börsig
Chief Financial Officer, Deutsche Bank AG.
Mr Thomas Fischer
Program Officer, Politics Division, The Bertelsmann Foundation.
HE Ambassador Hans-Friedrich von Ploetz
Ambassador of the Federal Refpublic of Germany to the Court of St James’s. JAPAN
Mr Toru Hashimoto
Chairman, The Fuji Bank Limited.
Mr Haruhiki Kuroda
Vice Minister for International Affairs, Ministry of Finance.
Mr Takeshi Ohta
Chairman, Advisory Council, The Daiwa Bank Limited.
Mr Toru Shikibu
Financial Minister, Embassy of Japan, London.
Mr Yasusuke Tsukagoshi
Director, Office of the Vice Minister for International Affairs, Ministry of Finance.
Professor Naoyuki Yoshino
Professor of Economics, Keio University.
Sir Leonard Appleyard KCMG
Vice Chairman, Barclays Capital.
Mr John Arrowsmith
HM Consul (Financial), British Consulate-General, Frankfurt.
Sir Nicholas Bayne KCMG
Fellow, International Relations Department, The London School of Economics and Political Science.
Professor Tim Congdon CBE
Managing Director, Lombard Street Research Limited.
Dr Jenny Corbett
Reader in the Economy of Japan, Nissan Institute of Japanese Studies, University of Oxford.
Mr Martin Donnelly
Deputy Head, European Secretariat, Cabinet Office.
The Rt Hon Lord Howell of Guildford
House of Lords Opposition Spokesman on Foreign and Commonwealth Affairs.
Mr Christopher Huhne MEP
Member of European Parliament for South East England; a member, Economic and Monetary Affairs Committee.
Mr Anatole Kaletsky
Economics Editor and Associate Editor, The Times.
Sir John Kerr KCMG
Permanent Under Secretary of State, Foreign and Commonwealth Office.
Professor Lord Layard of Highgate
Professor of Economics, London School of Economics and Political Science and Director, Centre for Economic Performance.
Mr Anthony Loehnis CMG
Director, J Rothschild Assurance Holdings, plc.
Mr Derek Scott
Economic Adviser to the Prime Minister.
Sir Andrew Turnbull KCB CVO
Permanent Under Secretary, HM Treasury.
Sir Nigel Wicks KCB CVO CBE
Lately Second Permanent Secretary (Finance), HM Treasury.
Mr David Willetts MP
Member of Parliament (Conservative) Shadow Secretary of State for Social Security. UNITED STATES OF AMERICA
Mr Michael Calingaert
Executive Director, US Branch, Council for the United States and Italy, and Guest Scholar, The Brookings Institution.
Mr Peter H Chase
Minister for Economics Affairs, American Embassy, London.
Mr Robert Conway
Senior Director, The Goldman Sachs Group Inc.
Dr Arthur I Cyr
A W and Mary Margaret Clausen Distinguished Professor, Political Economy and World Business, Carthage College, Wisconsin.
Mr Cary A Koplin
Managing Director, Private Asset Management Group, Neuberger Berman LLC.