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. Last Updated: 07/27/2016

Era of Benign Neglect May Be Over

Last week, eurozone finance ministers had a collective panic attack about the overshoot in the euro-yen exchange rate. I hear you say: so what? They can talk as much as they like, but since they are not in charge, we might as well ignore what they have to say.

The Maastricht treaty was unhelpfully ambivalent on whether finance ministers or the European Central Bank was in charge of exchange-rate policy. This meant that benign neglect became the eurozone's exchange-rate policy, not by design but by default. In the past, that would have ended the conversation.

But last week's big news was that the Germans had announced a subtle but important shift in their position on exchange-rate policy. Previously, the German government could be relied on to block any initiative that might remotely be construed as a challenge to the ECB's independence. But I was dumbstruck when I heard that Peer Steinbr?ck, Germany's finance minister, had declared that the ECB's independence related only to monetary policy and that it was natural for politicians to take an interest in exchange rates. Either he was way out of line or telling us some big news -- probably both.

Jean-Claude Juncker, prime minister of Luxembourg and head of the euro group, always wanted to strengthen the group's standing and start a regular dialogue with the ECB. What makes his long-frustrated endeavor more pertinent this time is that he now has the explicit support of France, Germany and, I suspect, Italy and Spain as well.

This is why the political balance is shifting. It is not a tectonic shift, but markets should take note nevertheless. This may well be the year when the contours of a European exchange-rate policy, conducted jointly by the euro group and the ECB, emerge. No, I am not talking about official or unofficial target bands, straight or fuzzy, or about currency regimes. The euro will, of course, remain a free-floating currency. What I am talking about is a political will to correct exchange-rate overshoots before they start to damage the economy.

The funny thing is that we all thought a massive devaluation of the U.S. dollar was what it would take to persuade the Europeans to adopt an exchange-rate policy. Nobody ever gave much consideration to the euro-yen exchange rate. For the ECB, the yen's exchange rate is almost irrelevant. It poses no dilemma for Europe's monetary policy. The ECB has no incentive to intervene in currency markets, except when its own monetary policy might be adversely affected. That happens from time to time, but only very occasionally and not now. This is why a political power shift is important. If the politicians take an interest in exchange-rate policy, the era of benign neglect may soon be over.

For the eurozone's politicians, the euro-yen exchange rate is a much bigger problem than for the Central Bank, since the eurozone and Japan produce similar products, such as cars, through which they compete directly on world markets. There is intense domestic pressure to do something about the fall in the eurozone's relative export competitiveness. The latest economic data, in particular last week's purchasing managers index, suggest that exports are already weakening in the eurozone.

Only German exports seem to be holding up reasonably well. After years of cost cutting, German industry may be in a better position to withstand a sharp currency appreciation, but it is not immune either. European politicians are afraid, with good reason, that this may well be the mechanism that ends the current economic recovery.

So what can they do? It appears they will not do much at this week's Group of Seven meeting in Essen. The Americans and Europeans do not see eye to eye on this issue. In any case, the United States is more concerned with China than with Japan. Behind the scenes the Europeans will complain loud and clear to the Japanese, who in turn can be relied on to ignore whatever the Europeans have to say. At the end of the day, the G7 will issue one of those communiques that take a long time to draft and say absolutely nothing.

But when this meeting is over, the Europeans will continue to complain about the yen and, if the yen were to decline further, I would expect the euro group to press the ECB to intervene in the foreign exchange markets at some point. Since the yen is subject to a huge amount of speculative interest, any such intervention might be risky, not only for the speculators but also for financial stability in general.

The Europeans are probably not the subtlest communicators when they believe something is out of balance. I recall when Helmut Schlesinger, then vice president of the Bundesbank, made some characteristically blunt remarks about market imbalances in the autumn of 1987, which triggered the stock-market crash. His comments were the perfect narrative the markets needed to panic.

Global financial markets are not yet in the habit of listening to the equally blunt Juncker. But I would expect that to change, as the euro group grabs at least partial ownership of exchange-rate policy.

If and when this happens, it will affect markets and, in particular, it will affect those investors who currently believe that the euro-yen exchange rate is a one-way bet.

Wolfgang Munchau is a columnist for the Financial Times, where this comment first appeared.