There is no time better than the present to recognize the dollar’s weakness. With the April 11 G7 meeting of Finance Ministers and Central Bankers just days away, government officials around the world have the power to stop the dollar from falling. But will they? Over the past 30 years, G7 meetings have marked big turning points for the US dollar.

According to the following G7 chart, significant tops and bottoms have coincided with a major change in the foreign exchange language of the G7 communiqué. For example, following the Dubai meeting in 2003, the Group of Seven called for more “flexibility in exchange rates.” Although this criticism was directed at China and Japan, it came on the heels of a strong dollar rally. The decline of the US dollar during the late 1980s was also halted when the Louvre Accord was signed in 1987 at the G7 Minister of Finance meeting. Even though the language in the communiqué is only changed every few years, G7 meetings matter because they have the potential to make or break the US dollar.

Whether or not the G7 meeting will matter this time around will depend upon how many members support a change in the FX language of the communiqué.

Where Do They Stand?

US - To date, the US has been reluctant to take any measures to address the dollar’s decline, and will most likely not agree to take any drastic steps this Friday. The weaker dollar has helped to boost exports and provides another avenue for the US government to stimulate the otherwise ailing economy. The US government continues to pay only lip service to the strong dollar policy because they know that the path to a stronger dollar is through a weaker one.

Europe – The members of the Eurozone that are apart of the G7 (France, Germany and Italy) are not expected to officially call for dollar strength either. Up until now there has not been evidence of a significant deterioration in the Eurozone economy, but we are reminded daily of rising inflationary pressures. Therefore the finance ministers and central bank governors of these countries will continue to allow the dollar to weaken because a stronger Euro helps to reduce price growth.

Japan – Japan and its Asian neighbors have been the hardest hit by the dollar’s weakness. According to government data, inflation in Japan reached a 10 year high during the month of February. Price growth in places like Vietnam are running at double digit rates while Saudi Arabia also touts the fastest inflation growth in 27 years. The rise in inflation has been due in large part by the weakness of the US dollar and these dire consequences are forcing many countries to reconsider their dollar pegs. Even China, who has received significant criticism about their artificially weak currency is now expressing concern about the falling dollar’s impact on the value of their foreign exchange reserves. However Japan and its Asian neighbors alone will not be able to convince the G7 to directly address the weakness of the US dollar.

Coordination is the Only Way That It Will Work

In order for the G7 to change the language in their communiqué, the US and Eurozone countries will need to support the change. Unfortunately a turn in the US dollar at this point is not in the best interest of either parties. If the diverging monetary policy directions of the Federal Reserve or the ECB tell us anything, it is that there isn’t much spirit for cooperation. With the dollar breaching the 7 Yuan mark, China has already made great inroads to strengthening its currency. Since the beginning of the year, the Yuan has appreciated 4.5 percent, compared to 7 percent growth in 2007. This gives the G7 little room to further criticize China because the problem in the world right now is not Yuan weakness but dollar weakness. One of the main reasons why inflation is reaching a record high around the world is because of the weakening dollar.

Current FX language

Here is the current G7 Finance Ministers and Central Banker’s stance on currencies:

“We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China's decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its effective exchange rate.”

How to Trade the G7 Statement

Previous experience has shown that G7 statements have brought significant trend reversals or continuations for USD and JPY pairs. These dynamics leave us with several trading scenarios on different outcomes in the meeting’s communiqué.

Most Likely scenario: Exchange rate commentary remains largely unchanged, with a specific mention of Chinese currency policy the only explicit mention in the G7 statement.

This outcome could lead to mild dollar weakness, but will pretty much make the G7 meeting a non-event.

Less likely scenario: Exchange rate commentary makes specific reference to US dollar weakness, with comments on China’s forex policy unchanged.

This outcome would be widely dollar bullish. Not only would it trigger a meaningful top in the EUR/USD but also lead to a sharp rally in USD/JPY.

David Rodriguez is a Currency Analyst at FXCM.