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In between bites of seal meat and dogsled races, the financial heads of the Group of Seven (G-7) countries met near the Arctic Circle in Canada last weekend to hammer out differences in how their respective countries will approach monetary policy as the economic recovery takes hold.
Windchill temperatures hovered around -40°C in Iqaluit, just south of the Arctic Circle, as finance ministers and central bankers from the world's biggest industrialized economies met. Mostly, they stayed close to their cozy fireplaces as they discussed the nuts and bolts of financial regulation and global imbalances.
Indeed, different countries emerge from their respective recessions at different speeds with divergent fiscal and monetary policies, threatening the collaboration that was forged during the financial crisis.
Countries are moving "from synchronous to divergent financial policies," Stephen Jen, a money manager at London-based hedge fund BlueGold Capital Management LLP, told Bloomberg News.
"For the asset markets, policy risks will become increasingly more important than economic risks," said Jen, who predicts the dollar will outperform the euro as U.S. interest rates rise faster.
"Different countries have taken different steps," Canadian Finance Minister Jim Flaherty told Bloomberg in a Jan. 29 interview in Davos. "It's time we have a conversation about that and coordinate more. I understand the political pressures some are facing."
Flaherty chaired the two-day meeting, which isolated the G-7 officials, including U.S. Treasury Secretary Timothy F. Geithner and European Central Bank President Jean-Claude Trichet, in the former whaling and fur-trading outpost deep in the heart of Nunavut, Canada's northernmost territory.
"Global growth could easily be choked off if policy makers prematurely withdraw fiscal and monetary policy support," Andrew Cates, an economist at UBS AG (NYSE: UBS) in Singapore told Bloomberg. "Investors have taken note of this fragility."
Other analysts are concerned divergent fiscal policies could slow the movement for new international banking regulations, which could create loopholes that could be easily exploited by big investment banks.
"On bank reform there is undesirable splintering when they need to work in synch and quickly," Barry Eichengreen, a University of California at Berkeley economist told Bloomberg.
Differences in fiscal policy are a growing concern for investors after governments reacted to the financial crisis cohesively by cutting interest rates to record lows and spending more than $2 trillion in fiscal stimulus.
A policy split among the major economies may be imminent, BlueGold's Jen told Bloomberg. The U.S. Federal Reserve may begin tightening monetary policy while the European Central Bank maintains its low interest rate. In Asia, he expects Japan to keep fueling monetary and fiscal expansions while China cuts back on both fronts.
"Such a divergence in policy mixes will be a source of volatility and a propellant of new trends in asset markets," Jen said.
The location of this weekend's meeting, a precursor to the "premiere forum" Group of 20 meetings to be held later this year, was a source of controversy by itself. Iqaluit is so remote it has caused more than a few raised eyebrows, with at least one official calling it "crazy."
But Canada's choice of location was intended not only to showcase its indigenous Inuit culture, but also to remind the world of its stakehold in the Arctic, which is both rich in natural resources and threatened by global climate change.
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