G-7 Seeks to Avert Collapse in World Confidence

Bloomberg

By Toru Fujioka - Aug 8, 2011

Group of Seven nations sought to head off a collapse in investor confidence after the U.S. sovereign- rating cut and a slump in Italian and Spanish debt intensified threats to the global economy.

G-7 finance ministers and central bank governors pledged in a statement to “take all necessary measures to support financial stability and growth.” Officials will inject liquidity and act against disorderly currency moves as needed, they said after a call late yesterday European time. The G-20, which includes emerging markets, issued a similar communique.

Stocks extended declines that have wiped $5.4 trillion off equity markets since July 26, driven investors to Treasuries and gold and rattled consumer confidence already hurt by European fiscal tightening and elevated American unemployment. The European Central Bank signaled it will buy Italian and Spanish bonds, and Japan warned it may intervene again to stem yen gains.

“The markets can’t see a light at the end of tunnel” even after the G-7 statement because the pledge of cooperation isn’t enough, said Atsushi Ito, a senior rate strategist in Tokyo at UBS AG, who previously worked at Japan’s finance ministry. “Each nation has to come up with specific and convincing measures but it will probably take a while.”

Stocks, Gold

The MSCI Asia Pacific Index of shares fell 2.7 percent as of 4:02 p.m. in Tokyo, heading for the worst five-day rout since October 2008. Futures contracts on the U.S. S&P 500 Stock Index lost 1.9 percent. The dollar reached an all-time low of 74.85 Swiss centimes before trading at 75.57. Gold pierced $1,700 an ounce in intraday trading for the first time.

Treasuries advanced, with benchmark 10-year yields at 2.53 percent, after trading opened for the first time since the S&P announcement of the one-step cut in the U.S. sovereign rating to AA+. Two-year yields dipped to a record-low 0.2520 percent.

G-7 policy makers committed to “coordinated action where needed,” and to “consult closely in regard to actions in exchange markets,” even as they reiterated support for market- set currencies. The group last mounted a joint foreign-exchange intervention in March, countering a surge in the yen after Japan’s earthquake.

While the G-7 statement was “better than nothing,” it’s not likely to stem the dollar’s decline, said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. Muto added that the scope for coordinated policy action is limited by inflation pressures, caps on spending, and interest rates that are already near zero in nations such as the U.S. and Japan.

Yen Rises

The yen rose 0.7 percent to 77.88 per dollar, about 2 percent from the postwar high reached in March. Investors flocked to the yen and franc amid the turmoil as currencies of nations with current-account surpluses. The yen’s gain risked damping a recovery from Japan’s estimated three quarters of economic contraction through June, by hurting exports.

Avoiding another “severe” recession may be “mission impossible,” Nouriel Roubini, co-founder and chairman of Roubini Global Economics LLC, wrote in the Financial Times.

In Europe, the debt crisis has seen yields on Italy’s 10- year government securities rising to 6.1 percent from 4.6 percent in two months, while Spain’s yields have soared to as high as 6.29 percent, from 5.14 percent in March. Ten-year borrowing rates for both nations have reached the most since before the euro was introduced in 1999.

Europe Debt

“No change in fundamentals warrants the recent financial tensions faced by Spain and Italy,” said the G-7, made up of the U.S., Canada, U.K.,Germany, France, Italy and Japan. Policy measures announced by Italy and Spain will “strengthen fiscal discipline and underpin the recovery in economic activity and job creation,” the officials said.

The statement added that “the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area.” The latest bailout package for Greece includes voluntary contributions from private-sector bondholders.

The ECB said yesterday it will “actively implement” its bond-purchase program, in a statement issued in the name of President Jean-Claude Trichet after an emergency teleconference meeting of policy makers, separate from the G-7 call.

The bank also called on all euro-area governments to follow through on the measures agreed in July, including allowing the European Financial Stability Facility to buy bonds on the secondary market.

ECB’s Shift

“It is on the basis of the above assessments that the ECB will actively implement its Securities Markets Program,” the central bank said.

After a series of calls involving German Chancellor Angela Merkel, French President Nicolas Sarkozy, Spanish Prime Minister Jose Luis Rodriguez Zapatero and Italian Prime Minister Silvio Berlusconi, European leaders pledged to push implementation of last month’s deal on the European Financial Stability Facility. Berlusconi announced measures to speed austerity and target a balanced budget in 2013, a year ahead of schedule.

“The ECB is now in for the long haul and will potentially have to buy up to half of the Italian and Spanish traded debt, the biggest risk-pulling effort ever engineered in Europe,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London.

Sovereign investors from Europe to Asia expressed confidence in U.S. government debt after the S&P decision.

Confidence in Treasuries

Japan, the second-largest international investor in American government debt, sees no problem with trust in the securities, a Japanese government official said on condition of anonymity two days ago after the S&P decision.

Japan’s efforts to weaken the yen may boost its need to purchase Treasuries, after the nation’s authorities mounted the third round of yen sales since September last week. Vice Finance Minister Fumihiko Igarashi said over the weekend that the government is ready to intervene again.

Russia considers U.S. debt reliable and won’t review its policy of investing in the country, Deputy Finance Minister Sergei Storchak said after the U.S. downgrade. The cut “can be ignored” for long-term investment strategy, he said. Russia, a Group of 20 member, is one of the 10 largest foreign holders of U.S. government debt.

G-20 finance chiefs said in a separate statement that members will take “all necessary initiatives in a coordinated way” to support financial stability and growth.

The U.S. Treasury Department said the S&P move was flawed by putting discretionary spending levels at $2 trillion higher than the Congressional Budget Office estimates. S&P responded that its judgment wasn’t meaningfully affected by such spending figures.

S&P Move

The S&P move went further than Moody’s Investors Service and Fitch Ratings, which affirmed their AAA credit ratings for the U.S. on Aug. 2, the day U.S. President Barack Obama signed a bill that ended the debt-ceiling impasse that had pushed the country to the edge of default. Moody’s and Fitch both said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.

“We can ask why this agency took this decision based on figures that are not consensual,” French Finance Minister Francois Baroin said in an interview on RTL Radio yesterday. “There will be a debate in the U.S. about this decision. It’s one out of three agencies. It’s only one element.”

S&P currently gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report. The U.K. which is estimated to have debt-to-GDP this year of 80 percent, 6 percentage points higher than the U.S., also has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P said in yesterday’s statement.

New Zealand

New Zealand is the only country other than the U.S. that has a AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

The debt downgrade and market slide are bound to hit the confidence of American consumers, said Mark Spindel, chief investment officer at Potomac River Capital, which manages $300 million in Washington.

“This is an upper-cut to confidence at the worst possible moment,” Spindel said before the G-7 announcement. “The downgrade mattered less. It is the path we have taken to get here: the meager recovery, the dysfunctional political environment, and the pathetic growth in employment, consumption and income that don’t seem to be moving back to sustainable levels.”

Confidence among consumers, whose spending accounts for 70 percent of the U.S. economy, fell to the lowest level in two years in July, a survey from Thomson Reuters/University of Michigan showed. The reached 63.7, the weakest since March 2009, when the economy contracted at a 6.7 percent annual rate.

Blackbaud Inc., a Charleston, South Carolina-based software company, and Blue Nile Inc., a Seattle-based online jewelry- retailer, both mentioned declining consumer confidence in earnings conference calls last week.

To contact the reporters on this story: Chris Anstey in Tokyo on canstey@bloomberg.net;

To contact the editor responsible for this story: Chris Anstey in Tokyo on canstey@bloomberg.net