[LFX]

Over the weekend, reports emerged that G20 would take up a US proposal to agree to mitigate global imbalances by raising savings in deficit countries (i.e., the US), increasing domestic demand in surplus countries (i.e., China) and making structural reforms in other economies to stimulate growth (i.e., Europe). According to the WSJ, this U.S. proposal, called the "Framework for Sustainable and Balanced Growth", would have no sanctions for noncompliance but would rely on moral suasion and peer reviews to be enforced.

One question is whether this is good or bad for the dollar. Most analytical models would say this is bad for the dollar, because the counterpart for higher US savings is lower rates, for the countries that increase domestic demand, higher rates. Similarly, if structural reforms raised the euro zone growth rate, that would raise the equilibrium real rate of return and presumably the equilibrium value of the euro. The US view may be that higher savings is a done deal for the US in the aftermath of the financial crisis, and thus committing to higher saving in return for other countries committing to higher domestic demand is a good trade.

The US would benefit by a reduction in the dependence on foreign capital and in the increasing need to appease foreign owners of Treasuries. For the euro zone, the attraction would presumably be the acceleration of EM domestic demand that might take some pressure off the EUR (although this isn't clear if governments continue to intervene in currency markets to prevent appreciation). Even without this, they might view stronger EM domestic demand growth as an economic plus, even if the G3 exchange rate consequences were undesirable. For EM, the article cites the bigger voting weight in the IMF, although they probably see a more limited need to buy Treasuries as a long-term plus.Once you get past the headline, the article focuses on the complexities of enforcing and implementing these commitments rather than the general sentiments.

Therefore, on the surface, this should be USD negative rather than positive. Moreover, this is a US proposal and presumably represents a US view that it is in the US interest for growth abroad to be as strong as possible. Asset markets have reacted negatively with equity futures down, interest rates down and commodities prices down. The second question is what makes this so USD positive and asset market negative.

This will probably be a major source of discussion over the coming days. In the background may be a discussion on whether the US would be willing to accept strict limits on executive compensation and maybe even a Tobin tax in order to sign up the Europeans and rest of the world to a stronger domestic demand commitment. It is also unclear how general commitments to a stronger domestic demand could be enforced versus specific commitments to Tobin taxes or pay limits.