Dubai doubts rock dollar

THE Ministers of the G7 countries had hardly clambered into their limousines to depart from Dubai before the flak started to fly in the markets. Most of it hit the dollar, but the knock-on effects upset shares and bonds across the world.

The Japanese yen soared to a three-year high in dollar terms. That makes life more difficult for Japan's exporters and Tokyo shares tumbled. The pattern was repeated in Europe as the euro, recently at $1.08, advanced almost to $1.15, and German, French and Dutch equities suffered.

Stock markets were pretty sickly all over. London's Footsie, having brushed 4300 last week, went below 4200 in mid-afternoon, though it rallied before the close.

Wall Street fell 130 points in its first half hour. Bonds, seen as safer havens in such times, recovered sharply from their dizzying recent falls.

What did the world's finest economic brains do to set off such turbulence? They simply cobbled up the opinion that 'exchange rates should reflect economic fundamentals'.

Thus emboldened, they went on: 'We emphasise that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial systems, based on market mechanisms.'

That sounded as innocuous as an endorsement of motherhood and apple pie (subject, of course, to the mechanisms of the mother and apple markets). But, as our City Editor warned on these pages yesterday, it hit the markets like a small bomb.

'The strong dollar policy is now officially declared dead,' said Morgan-Stanley's currency strategist Stephen Jin.

The greenback, recently at 115 yen, fell to 111 at one point. One banker predicted the euro would reach $1.30 within a year. Sterling held steady in euro terms while soaring from $1.63 to $1.6540.

Bonds and gold were the beneficiaries. Bullion climbed nearly $6 an ounce to $385.50. UK bond yields, which recently soared to 4.8%, fell below 4.6%. But they were 3.9% in June and the volatility is worrying. Economists are now expecting that UK interest rates will hit 4% or even 4.5% next year.

A fall in the dollar is no harm. The US is running an eyewatering external payments deficit along with its equally daunting budget deficit.

If President George W Bush is to be re-elected, he needs to stoke up the US economic engine. If that drags the rest of the world to a speedier recovery, so much the better.

The Americans were accordingly frank, behind the scenes in Dubai, about their wish to see the dollar lower against the yen and the Chinese-yuan, to curb the massive US trade deficit with China.

So far, so sensible. The snag is that the G7 comments can be interpreted in more than one way. The Bank of Japan claimed the seven nations' basic stance on currencies was 'unchanged'.

If Japan keeps intervening massively to hold down the yen, the 'market mechanisms' the Dubai communique discussed will not have much chance to operate.

But it seems wise to wait and judge by the actions of newly re-elected Japanese premier Koizumi and his new finance minister. The slump in Tokyo shares is a warning that allowing the yen to rise may not be a pain-free policy.

European markets were steadier last night as nerves settled. But confusion is not something that either currency or share traders relish. Nor is it conducive to the 'smooth and widespread adjustments' which the G7 would like.

Everyone knows what these really are - a revaluation of the yen and yuan, and a drop in the dollar that copper-fastens US recovery. The trick is to achieve this without it turning into a full-scale dollar-collapse. The sharp falls early yesterday are a warning that the markets can easily be spooked.

Industry gloom

THE CBI's concern about UK manufacturing is nothing new, but the 900 business and trade union leaders gathered at its Birmingham annual dinner last night heard evidence that it is growing more acute.

Manufacturing's share in the economy has declined from 21% when Labour took power in 1997 to 17%. Some shrinkage is inevitable as jobs move east to Asia, but CBI boss Digby Jones points out that the fall is greater in Britain than in the US, France or Germany.

Manufacturing still earns £150bn export revenues per year and employs 3.5m people.

Global markets are tough enough without adding new burdens of taxation, regulation and the persistent failure - despite hefty public spending increases - to deliver improvements in transport and basic services.