Forex Investment and Currency Trading

The communiqué published by world leaders at the conclusion of the G20 summit in Pittsburgh offered few surprises. Of interest, the communiqué referred to the G20 as the “premier forum for our international economic cooperation”. This effectively represents an acknowledgement that this expanded group of countries (representing 90% of global GDP and two-thirds of the world’s population) will be the key forum to discuss economic issues in the future.

Reflecting this shift, world leaders pledged to re-allocate at least five percent of the quota representation of the IMF to emerging and developing economies by January 2011. Reassuringly, world leaders also pledged to avoid any “premature withdrawal of stimulus”. At the same time, they promised to withdraw policy support in a “cooperative and coordinated way”. While cooperation and coordination are always nice things, in practice, it is not clear what such a pledge actually entails. The global recovery is likely to be highly differentiated, with countries that had few macro imbalances prior to the crisis set to rebound more quickly than countries that had overvalued housing markets, sizable trade deficits, and highly indebted consumers. This suggests that the withdrawal of stimulus will (and should) vary substantially across countries. In particular, analysts expect a number of emerging markets as well as some of the smaller and more resilient advanced economies like Norway and Australia to be among the first to raise rates, whereas larger advanced economies like the US and Japan are unlikely to raise rates at least until 2011.

As expected, G20 leaders pledged to increase banking system capital ratio requirements. While the specifics have yet to be worked out, it is worth noting that such changes may have a greater effect on Europe than the US given that Europe’s financial system is more heavily reliant on bank intermediation (in contrast, America’s financial system is more reliant on securities markets, with banking institutions making up only about 20% of all lending). The higher capital ratios could dampen investment spending in Europe, with a simulation analysis showing that an increase in the capital ratio of 2 ppt above its historical average could dampen investment by 0.2%-0.8% in the long run. In Japan, such changes could also have important consequences for the banking system, especially if regulators focus on increasing common equity capital ratios as opposed to just Tier 1 capital.