Outline Of A New World Currency System
The financial and economic crisis and the drastic situation in the Eurozone have shown the limitations of liberalised markets in ensuring – of their own accord – some sort of consistent order. For more than thirty years, our politicians have relied on the theory of efficient markets, i.e. on the generalised dismantling of barriers to trade, liberalisation of financial markets and the opening up and increased flexibility of labour markets. The financial and economic crisis almost completely shattered the illusions surrounding this theory. Without state rescue measures, the market would have plunged most of humanity into deep crisis.
The financial and economic crisis has deprived global markets of their authority. Global markets lack institutions which, at national level, ensure that markets function properly. A monetary framework, a legislative environment, a socio-political providing for distributional justice and a political authority with international legitimacy are missing at global level. It is only once we accept that markets are inefficient, i.e. that they do not work optimally in an economy of their own accord, that we are able to apply a different strategy: We need an approach involving political control and guidance of market forces. Therefore, international political authorities must – by the use of suitable rules, institutions and political measures – give the markets such direction.
Monetary Disruption Of The World Economy
Price-formation takes place in a flexible exchange rate system between currencies through supply and demand. Currency markets have replaced exchange rates set at political level, and now determine, each day, the value, purchasing power and ‘terms of trade’ of any national economy vis-à-vis the rest of the world. The outcome is disastrous: Exchange rates fluctuate more and more, fluctuations are more severe and market players have to plan on an increasingly short-term basis. That is the reason why the exchange rate between the US dollar and the Euro is becoming increasingly volatile.
Exchange rates and capital movements do not mirror trade flows and the economic development of the currency zones in question. They have decoupled from developments in the real economy. Therefore, companies and market participants are obliged to cover themselves against exchange rate fluctuation by resorting to currency futures markets. In such circumstances, currency speculation is bound to occur. What’s more, capital movements on increasingly liberalized international finance markets, such as for the acquisition of new shares or bonds in another currency zone, always require foreign exchange transactions. Severe turbulence on the share and bond markets can therefore cause considerable upset for the exchange rates of the currencies concerned.
A New World Currency System
Foreign exchange markets are characterised by the dominance of a few currencies, like the US-Dollar, the Euro, the Japanese Yen, the British Pound and the Swiss Franc. These markets do not reflect the multi-polar system of the world economy. It is characterised by three centres of growth: China, Northern America and Europe with their regional ambitions. If this dominance continues, it amounts to surrender to inefficient currency markets, and will, in turn, lead to further crises and currency wars.
Given the conditions and challenges already described, it would be wise first to establish a new fixed but adjustable exchange rate system. As a role model, the European Monetary System (EMS) can be considered. There is a need for exchange rate certainty, achieved through fixed exchange rates, but there must also be a room for politically controlled adjustments, where the balance of payments situation so requires. Such an international currency system has not been all-encompassing, and it needs not to include all currencies and economies with their radically differing structures. It is far more important to create a system which can lead the way for other countries.
Leadership would be provided by the most important central banks of the industrialised and threshold countries, with a view to creating a stable monetary foundation for the world economy. As well as the five most significant lead and reserve currencies (Yuan, Yen, US- Dollar, Euro, Swiss Franc and Pound Sterling), the system should include the currencies of the most significant threshold countries, such as India, Brazil and others such as Russia. It would then cover the most important centres of economic growth.
World Currency System
The lead currency could be an artificially created unit of account, exchange rates between currencies could be kept within a band of ± 2.5%. The value of such a “World Currency Unit” (WCU) could be determined by using a basket, made up of weighted shares of the individual national currencies. The relative importance of each of these would be calculated according to various general economic criteria, such as the country’s share in world Gross Domestic Product, or the significance of the currency for international trade.
The WCU would be the pivotal point, key for setting exchange rates between the currencies participating in the new world currency system. All exchange rates would initially be set vis-à-vis the WCU. Exchange rates between individual currencies in the system would be formed only indirectly by using their rates vis-à-vis the WCU. This would prevent direct and isolated bilateral exchange rate fluctuations and the creation of new bilateral exchange rates. Rates between a participating currency and the WCU could therefore vary by up to ± 2.5%.
If there were any risk of greater fluctuations outside the ± 2.5% framework, the central banks involved would undertake to intervene together to bring the exchange rate back within the allowed bands. To this end, participating central banks would undertake to provide unlimited credit for intervention purposes, on a reciprocal basis. As well as this, the role of the IMF (International Monetary Fund) should be strengthened. If a country had balance of payments difficulties, the IMF could grant short and medium-term loans, as well as reserve-based credit facilities, in order to keep exchange rates within the agreed limits. The IMF would thus take on the function of ‘lender of last resort’ in the new global currency system.
Summary
Flexible exchange rate systems have resulted in neither greater resource efficiency nor monetary stability. It is now time for a policy of greater regulation, and for a radical institutional about-turn. Unregulated markets are by their very nature inefficient and can only function properly with political direction. Leaving them to their own devices always spells disaster. In the area of monetary policy, we must no longer assume that flexible exchange rates and currency markets are the best option. We will then be open to ideas for a new fixed exchange rate system for the world economy. The model described here is just one suggestion of a systemic break with the dominant school of thought.
A Country Matures, An Exchange Rate Declines
After two weeks on the road visiting clients your analyst returns with a better view of the consensus outlook. There is, though, much in the consensus to disagree with. In particular it seems peculiar that the consensus believes the democratically elected government of Italy, with policies entirely contrary to EU membership, will be put through the bureaucratic meat grinder in Rome and Brussels and turned into EU sausage, in a similar process that minced the political representatives of Greece.
While this might well be the case, it is hard to understand that the grinding destruction of this democracy, even if it is only moderate compared to the Greek experience, can be anything but bad for growth and asset prices in the EU. Disciplining these politicians to abandon their manifesto promises and follow the ways of the EU is highly unlikely to be a painless experience, either for Italy or the rest of the EU. Nonetheless, investors are content to believe that a painless disciplining of Italy’s elected representatives is all but inevitable. We shall see.
Perhaps the most prevailing consensus view is that the recent weakness of the RMB represents a Chinese counter-punch in the trade war with the US. Coming when it does, it is easy to see the accelerated decline of the RMB as a tactical and not a strategic move. Comments by the PBOC on July 3rd have probably reassured many investors that the managed exchange rate regime is not at risk and that the RMB will continue to be managed against a basket of currencies. Your analyst does not agree.
Readers of the Q2 2018 report (When Monetary Systems Fail - A Guide For The Cautious) will know why the decline of the RMB exchange rate is part of a larger change in the global monetary system. It is a change that is initially deflationary and accompanied by a likely credit crisis. Of course, such a breakdown has been close three times post-GFC with first the European debt crisis (2011-2012), the taper tantrum (2013) and in the commodity price collapse that ended with the so-called Shanghai Accord in Q1 2016. So it is not surprising that market participants believe that, once again, central bankers stand ready to stick their fingers in the dike that holds back the market forces of deflation associated with the end of the current global monetary system. The recent movements in the RMB show that Jay Powell’s refusal to join the shoring-up party has prompted a fundamental shift in Chinese monetary policy.
Investors need to prepare for a formal widening of the trading bands for the RMB relative to its basket and the problems such a move will create for all emerging markets. That first move in the RMB is inherently deflationary. This is no counter-punch in a trade war; it is the beginning of the creation of a new global monetary system.
While many investors now concede that an emerging market debt crisis is likely, few are prepared to concede that China will be caught up in it. China is always seen as different and of course, in many ways, it is. It may well manage its exchange rate against a basket of currencies, dominated by the USD, but it has tools to manage this relationship that most countries do not.
Its exchange controls allow it to manufacture a capital account surplus, although those controls are not a perfect dam for capital outflows. By creating a larger capital account surplus than would otherwise occur, China maintains the total external surplus that leads to rising foreign exchange reserves and hence growing domestic commercial bank reserves. It thus extends the period of growth. Also, the state owns the commercial banking system and so can force it to keep lending, thus continuing to create RMB, when the growth in commercial bank reserves would dictate more moderate credit growth in a truly private banking system. While these tools allow China to extend the business expansion within the managed exchange rate regime, they do not permit it to abolish the business cycle. If it were so, everyone would be adopting similar policies.
At least since the time of David Hume (died 1776) and probably since Richard Cantillon (died 1734), we have understood how the downtrend in the business cycle is enforced in an exchange rate management regime. It is inevitable, in such a regime, that the enforced excess creation of money leads to a deterioration of the external accounts, an end to money creation and slower growth, often accompanied by deflation. There are natural forces at work within a managed exchange rate that cannot be resisted. Nobody yet has found a way to obviate that cycle, though many have extended it. China’s ability to use its capital controls and commercial banks’ balance sheets to temporarily override those natural forces has now come to an end.
The ability of China to extend the cycle has come to an end as the current account surplus has all but evaporated - a natural consequence of extending the growth cycle by keeping money too loose when the external account deterioration dictated that it should be kept tight. It has come to an end as the capital account is at best in balance rather than surplus. It has come to an end because the RMB is primarily linked to a strong currency in the form of the USD. It has come to an end because the Fed is both raising interest rates and destroying high-powered money to the tune of USD360bn a year. It has also come to an end because Jay Powell has warned China, and other emerging markets, that he will not alter the course of US monetary policy to assist with any credit disturbances outside his own jurisdiction.
And if that were not enough, it has come to an end because the US runs small current account deficits, by its own historical standards, and the President of the USA seems determined to make them even smaller. Investors now need to ask a bigger question when considering the future for Chinese, and thus emerging market, monetary policy. Why would anybody want to link their currency to the USD?
As a graduate of the University of Cambridge, your analyst can attest that things often done for the soundest of reasons can continue to be done long after they cease to make any sense. Such behaviour is the social habit we often proudly call tradition, or as Henry Ford put it more eloquently -
‘History is more or less bunk. It’s tradition’’
In the field of monetary policy, following tradition is both dangerous and unsustainable and doing it one way because we have always done it that way is not an option. Investors need to think not about the long tradition of the RMB link to the USD, but whether today such a policy makes sense. Indeed, one thing we can all forecast, with a very high degree of probability of being right, is that one day China will have an independent monetary policy as one of the world’s largest economies.
It is of course a big call to say that the tradition of linking to the USD is ending now and a new independent monetary policy is in the process of being created, but that time has come. Japan, the Eurozone, the UK, Canada and Australia are just some countries that manage their monetary affairs free of any de facto or de jure link to the USD. China is now joining the club, and other emerging markets will either have to decide to move to a free float or, believing that China is now capable of running major current account deficits, move to linking their currencies to the RMB.
So why is it now that China is maturing into a country with an independent monetary policy? It is a combination of a change in the Chinese economy and also a change in the nature of the US economy, and what the US wants to be to the world economy. The US is a country where the current account deficit relative to GDP has been less than 2.5% since 2012 - compared to a deficit of almost 6.0% of GDP at the peak of the last business cycle. President Trump appears determined to reduce even this moderate deficit.
If the US is not to run ever-bigger deficits, how can those linked to the USD run ever larger surpluses? Such surpluses force a rise in foreign exchange reserves and the creation of domestic base money thus facilitating higher economic growth. This tightening of monetary policy through smaller US current account deficits can be somewhat offset, if US interest rates are declining, with positive impacts for capital flows to those managing their currency relative to the USD. However, as it happens, interest rates are rising and as readers of The Solid Ground Q1 2018 report will know, the contraction in the Fed’s balance sheet exacerbates the problem.
To add to the problems for those linking to the USD comes the statement by Jay Powell in Zurich on May 8th that he bears no responsibility for the consequences of his monetary policy on emerging markets. In short, it is a system where the de facto lender of last resort has absolved himself of liability. China and other emerging markets will know why they started their managed link to the USD but they will be hard pressed to work out why they continue with it.
At this stage nobody can really move onto a new monetary system until China moves on. If any form of managed exchange rate is to form part of EM monetary policy, then the most important thing to establish is who will run the world’s largest current account deficit. China has been a mercantilist since the death of Mao, and Japan and Germany/Eurozone are all bent on running current account surpluses. While President Trump’s policies may be contradictory in terms of what they will achieve, his resort to non-market mechanisms in terms of tariffs show it would be too dangerous to believe that he will ultimately fail to generate his desired US current account surplus.
So, who can run the current account deficits necessary to make their currency an attractive anchor for smaller countries seeking to run current account surpluses?
It seems well nigh impossible to believe, following almost 40 years of mercantilism, that China would opt to become a country running large current account deficits. Such a change in the mindset may seem revolutionary, but it is just another necessary shift in the long game in the attempt to make China the pre-eminent global economy. Already the move to a more consumption orientated economy has all but eradicated the country’s current account surplus.
Yet this is a country still with a long way to go in reducing its reliance on investment as a component of its economy. It is a country with a level of debt to GDP that is growing more rapidly than any other country in the world. It is, in short, a country that needs to further accelerate consumption and generate sufficient growth in broad money to inflate away its excessive debt level. It is very difficult to see how those key goals can be achieved without running a material current account deficit associated with much higher nominal GDP growth. This country needs an independent monetary policy.
That independence can only come from abandoning the exchange rate policy and generating the level of high nominal GDP growth, in a world of low nominal GDP growth, that will produce a major decline in the exchange rate. As argued above, structurally and cyclically it is time for China to move on and to take its full place with those independent nations that do not rely upon others to ultimately determine the price and quantity of money of their domestic currency.
The initial shift to a more flexible Chinese exchange rate is deflationary and dangerous. The USD selling price of Chinese exports will likely fall, putting pressure on all those who compete with China - EMs but also Japan. The USD will rise, putting pressure on all those, particularly EMs, who have borrowed USD without having USD cash flows to service those debts. With world debt-to-GDP at a record high, such a major deflationary dislocation can easily trigger another credit crisis and The Solid Ground has previously focused on where such credit events are likely.
However, following the great dislocation, China will be free to reflate the world, for such will be the potency of the monetary policy of such a large economy relaxed about running a current account deficit.
Investors should not bet on this happy outcome. There will be deflationary pressures and a potential credit crisis to navigate first. At any time in this process very unpredictable political feedback could delay or prevent China’s move to its new role. So, prepare for the deflationary consequences of this shift in the global monetary system, and expect as well as hope that it too will end as China helps the world to inflate away its debts.
FIRST it was the U.S. government, then the Fed, and later the Chinese. Over the last decade, a steady flow of villains were supposed to murder the greenback. Through poor economic policy, overuse of the printing press, and sheer economic muscle, these financial bad boys were clearly going to knock the U.S. dollar off of its pedestal, right? That would obviously lead to devaluation, followed by rising U.S. interest rates and bone-crushing, unstoppable inflation. There were only two questions: What asset should you buy before this happens (the normal answer being gold), and when will it occur? Those waiting for the dollar apocalypse will have to keep waiting. Yes, the U.S. government made some dumb financial moves, and yes, the Fed perpetrated the greatest theft in all of history. However, the Chinese don’t have near the monetary might that people assume. But none of this is the point. Valuing currency doesn’t happen in a vacuum. If one goes, another must rise, and that’s where the U.S. dollar shines. To think that investors, nations and large corporations will suddenly abandon the U.S. dollar implies that they will immediately embrace some other currency. This line of thinking misses the colossal change in the way currencies work since Nixon took the U.S. dollar off the gold standard in 1971. We now operate in financial ether, where no currency is backed by a precious metal. Instead, currencies are valued against each other, and production and trade determines this value. Because of this, the greenback is far and away the most widely-used currency on the planet, and it shows no signs of losing its place. So anyone holding out for the Fed to be punished for its larcenous, money-printing actions will be sorely disappointed. And those expecting the Chinese to elbow out the greenback simply because their currency was added to the IMF’s Special Drawing Rights (SDRs) will also be left scratching their heads. More importantly, anyone basing their financial future on a falling dollar will be not just disappointed, but left behind financially. It’s All About Trade The important thing to remember is that traditional definitions are no longer valid. In today’s world, where no currency is pegged to a precious metal, a reserve currency is not a storehouse of value. Instead, it’s all about trade. It is easy to say that most companies and countries conduct trade in U.S. dollars, but the reasons for this, as well as just how deeply the greenback is embedded in international trade, can’t be overstated. The dollar’s ascendancy in terms of international trade began when other countries started breaking their
ties to the greenback. That left the dollar as the only currency that was still tied to a hard value. This made it the preferred choice for international trade, and put the U.S. in a dominant position where it could demand trade on its terms. In today’s world, the international obligations referred to earlier typically take the form of exchanging currency with domestic traders who buy and sell in other countries. To conduct international trade, companies have to agree on the method of payment. This involves settling not only on the terms, but also on the currency to be used. For example, when exporting to the U.S., a company will typically price its goods in U.S. dollars. This allows the price to remain the same to the U.S. consumer, even though the selling company is taking a risk on currency volatility. It works the same in other countries. When selling in large quantities, it makes sense to price goods in the currency of the final buyers, because it allows them the luxury of stable pricing over time. This means the countries with the largest imports will drive international trade in their home currency. Starting in 1971, the U.S. began importing more than it exported, leading to a negative balance of payments almost every year since. This left excess dollars outside the U.S. that could be used to meet obligations among foreign parties or invest back in the U.S. In addition to money outstanding, the U.S. also maintains a sizeable debt. While having debt isn’t seen as a good thing, it actually facilitates a reserve currency, because it provides foreign holders of the currency with a place to store their funds. Instead of simply holding cash balances, international investors can purchase U.S. debt in order to invest the funds they hold in something considered safe and liquid. All of this implies a free flow of capital across international lines. Holders of U.S. dollars or even U.S. debt are free to exchange or sell their holdings as they see fit. This free flow of capital is one of the main tenets of any currency that is to be used for international trade settlement and global payments. Another factor that has caused dollar supremacy is that, over time, goods that can be substituted for each other tend to be priced in the same currency. This allows for easy comparison among providers and is called “coalescing.” Given that the U.S. was and remains a very large buyer of goods, and that many markets around the world used greenbacks in order to eliminate local currency fluctuation, many raw goods came to be priced in U.S. dollars. The most obvious example of this is oil. No matter how hard the Iranians and others try, most oil transactions are still priced in dollars. This makes sense when you consider what would happen otherwise. If any exchange priced oil in something other than dollars, then an arbitrage opportunity would potentially exist, allowing participants to pit sellers against each other. Every time the exchange rate of a currency pair changed, so would the price of oil in one currency or both. If the value of the dollar falls against the euro by $.01, does oil become more expensive in dollars on an exchange based on euros? To avoid such confusion, sellers of such commodities tend to follow each other and simply use one currency to price their goods. The Dollar is Here to Stay Looking at reserve currency through the lens of trade brings a lot of clarity to our current situation. It is obvious that the dollar enjoys a unique position in terms of international trade settlement, but this position is not due to any love affair that other countries have for our currency. It is simply a matter of efficiency and size. Yes, the Chinese renminbi has come on fast, but there still exists a vast gulf between the dollar and everyone else. In 2013, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) announced that the renminbi had surpassed the euro to become the second most widely used currency for settling international trade. Three years later, the euro has recaptured second place from the renminbi, but the Chinese in the global picture, have gained ground somewhat. The question is: “How much ground?” The Bank of International Settlements (BIS) compiles a report on foreign exchange transactions (forex) every three years. In 2016, the dollar was party to 88% of all such transactions, which is up from 87% in 2013, and up from 84.9% in 2010. By comparison, the renminbi was party to just 4.0% of all transactions in 2016. The stark difference, even in the face of rising use of the renminbi for trade finance, reflects the complexities of international finance and illustrates why the renminbi will not seriously challenge the U.S. dollar as the world’s reserve currency. In terms of global payments — not trade finance — the world breaks out a little differently. SWIFT reports the top five currencies used for global payments as: These numbers are clearly concentrated in U.S. dollars and euros, with British pounds a distant third. Notice the absence of the renminbi. When it comes to global payments, the Chinese currency is ranked sixth with a 1.68% share, twice of what it was three years ago, but still with significant catching up to do. This is double its percentage from three years ago, when the renminbi’s share of global payments was 0.84%. But it’s still extremely small when compared with the world’s most popular currencies. The difference between the amount of renminbi used for trade finance and the amount used for global payments points out a distinction that illustrates why the renminbi should grow dramatically in terms of international use without ever seriously challenging the U.S. dollar. It’s the difference between trade and capital. What I mean by that is China is a big international trade partner. In fact, in 2013, it overtook the U.S. as the world’s largest trading nation. So it makes sense that parties trading with China would use more renminbi one-on-one with it, either financing their trading or making a payment to the Chinese. However, for third-party transactions (i.e., ones that don’t involve China) no one is using renminbi. This is where the dollar still reigns supreme. That’s why I fully expect use of the renminbi to grow, but only as it relates to financing and paying for direct trade with China. I don’t expect it to become a currency used in third-party transactions. As for the renminbi joining the SDRs last year, before it happened, we pointed out that it would be a nonevent. SDRs are not units of currency used in trade. They simply represent deposits of currency that IMF member nations can access when their currency is in turmoil. The renminbi now makes up about 11% of the SDR basket. However, that basket only holds $300 billion overall, so there’s about $33 billion worth of renminbi sitting at the IMF. So what?! Over $5 trillion of currency trades every day. The modest amount at the IMF, and the even smaller amount attributable to the Chinese currency, is meaningless. Even more importantly, the Chinese simply have no interest in making the renminbi into a reserve currency. They would have to give up control… not something they’re keen on doing. For the renminbi to gain significantly wider use as an international currency, there would have to be a huge supply of renminbi on the international markets. People in countries around the world would have to have access to the currency through some- thing as simple as a forex counter at their local bank. This is something that is possible with the dollar, euro and even yen today. In short, before payments can be made in renminbi, people have to have renminbi. Remember from above that one of the main ways that people get greenbacks is through our negative balance of payments. The U.S. imports more than it exports, sending hundreds of billions of dollars abroad every year. These funds are available on the international market for trade. The Chinese do not run a negative balance of payments and have shown no interest in doing so anytime soon. Then there is the matter of what a country or institution would do with their excess renminbi as they held it. The Chinese government does not issue many bonds. There is no readily available market for investing renminbi that is considered both safe and liquid. The only thing a country or company can do easily is buy more stuff from China, which puts people right back in the game of direct trade with the country that issued the currency in the first place. This would suit the Chinese just fine, but would not help countries that might want to use their reserves for something other than more trinkets from the Middle Kingdom. A more esoteric point is the question of hedging. For companies and countries to build and use large currency positions for international trade, they must be able to hedge their holdings whenever they see risk. This would imply a well-developed, functioning capital market that includes futures trading. This does not exist for the renminbi today, although it would be the least difficult piece of the puzzle to address. A final thought on the U.S. losing its status as the reserve currency is to ask: “Why would anyone else want that burden?” In the world today, every country is busy trying to export its way out of a financial mess. The U.S. wants to send more stuff abroad, the Europeans are counting on the steady flow of BMWs and Audis off the continent, and China continues selling all it can to other nations. Everyone wants to be a net exporter. But when a currency gains favor — and everyone rushes to buy it — the currency goes up in value. This means that country’s exports become more expensive. Why would China — or the euro bloc or Japan for that matter — want to encourage international players to buy more of their currencies simply to use them as reserves? They’d completely undermine their efforts to boost exports and alleviate their economic weaknesses. Putting this all together, it is clear that the U.S. does not enjoy its position as the reserve currency due to any goodwill, or because the U.S. has been so financially responsible. It is simply a matter of currently accepted practices (coalescing), the availability of dollars, the welldeveloped status of capital markets, the size of U.S. trade, and the fact that becoming the reserve currency would not be to anyone’s benefit. Unless something dramatic occurs, the Chinese renminbi will grow in use to match a substantial portion of the trade of the country but likely no more than that. Meanwhile, the euro bloc and Japan continue their efforts to devalue their own currencies, not make them more expensive. For those of us in the U.S., it means that Fed-printing will not lead automatically to a decline in the use of the dollar abroad and, therefore, will not cause a drop in the value of the greenback. Anyone pinning their hopes on a cheaper dollar — by purchasing inflation-protected assets like TIPS or gold — will be disappointed. In fact, the opposite is likely to occur. When the U.S. and the world hit the next rough spot, the U.S. dollar is likely to spike in value, not fall. The Dollar is the Ultimate Safe Haven As the biggest, strongest, richest kid on the block, the U.S. dollar has a great many detractors. But despite the copious gripes of those critics, the dollar remains the ultimate safe haven in a financial crisis. As the next round of deflation takes hold, a strong dollar will mean that anyone who has a claim on streams of income can purchase more assets, more services and a higher quality of life down the road. As for future growth, our economy appears to be in a “muddle-through” mode, while consumers continue to shed debt (excluding student loans and car loans) despite ongoing income stagnation. All of this puts us on the path of deflation, which is quite normal after such an incredible boom in debt as we had in the 1990s and 2000s. Debt deleveraging, deflation and a strong currency all work to drive interest rates down, or simply hold them at low levels, and to boost the value of cash, not inflation-protected assets. This means that people who are busy buying assets could be in for a rough ride, while those who are amassing streams of income are buying protection. The U.S. dollar has proven itself as the undisputed champion in the currency arena. It’s the reserve currency to the world’s $70 trillion economy. It’s the most ubiquitous method of payment. And it’s the best currency investment in times of global financial turmoil. Trumping the Buck The biggest “X” factor facing the U.S. dollar isn’t the Fed or the Chinese, it’s our own president. The newly-elected Commander-in-Chief has put forth several proposals, some of which would strengthen the dollar, and others that could cause it to weaken. Will we have trade skirmishes that slow the flow of dollars overseas, starving the world of greenbacks and pushing up their value? Will we have expansive new infrastructure spending with no offsetting reductions or tax increases, leading to larger deficits and potentially inflation? Will we have both? At the moment, there’s no way to know. Even as these plans come into sharper focus, it will be months or even a year before the outcomes are known. But remember that these are adjustments at the margin. The bigger questions regarding the dollar, like its status as the reserve currency of the world and its place among rivals, is settled for years to come. As policies unfold and we learn more about how they could affect the value of the dollar and any other commodities, timing will become increasingly important. During some periods, investments in particular stocks could be very profitable, while others could be costly. This is why you should follow our weekly email alerts and monthly issues of Boom & Bust closely. This is where we’ll tell you what’s coming next, what to do about it and how to adjust your financial plans and portfolio for maximum benefits, and minimum pain. In short, we’ll guide you step by step. Need For Global Financial Reset Growing Since IMF Analysis Shows GDP Has Only Doubled In Last 20 Years While Debt Has Grown By Over 320%
One of the primary reasons why we are seeing more and more rumblings about both a global financial and currency reset is in large part due to the fact that central banks have lost control over their monetary policies. By this we mean that over the past 20 years, the ever growing use of debt and credit to stimulate economies has resulted in less return on their dollars/euros/yen/yuan, etc…, or a validation of the Law of Diminishing Returns.
Chart courtesy of SRS Rocco
Over the last 20 years, the IMF estimates that global debt has increased from $74 trillion to $238 trillion while the global economy has grown at about half that rate, from $36.5 trillion to $79.6 trillion. This process is creating financial claims on the real economy that far exceed the increase in production of goods and services.
At some point, this ratio of debt creation to gdp growth will reach exponential proportions, and is a significant factor in governments and central banks all beginning to conduct serious talks on bringing about a reset to the financial and monetary system.
The Bank recognises that a new economy, a new world and new demographics demand a new financial system.
While we prepare for great change, we will be guided by one constant: our mission to promote the good of the people we all serve.
This infrastructure must be overhauled now that the economy is on the cusp of the fourth industrial revolution and our demographic challenges are intensifying.
And rebalancing of the global order is proving as dramatic as it was in Montagu Norman’s time.
Such profound changes demand a new finance.
We now have a balance sheet fit for a new world order with greater reliance on markets in a wider range of reserve currencies. However how each individual nation to preparing for this is an interesting dichotomy unto itself. In the East for example, nations like China, Russia, the Brics, and Turkey are accumulating gold at a record pace, while also constructing financial platforms such as CIPS and the AIIB to absorb the functions of both SWIFT and the IMF should these institutions collapse during a black swan event or through mutual decision.
Unfortunately in both the U.S. and in Europe, their answer appears to be the doubling down on their debt creation until the system simply implodes upon itself as it nearly did 10 years ago.
Both the world and individuals nations have gone through financial and currency resets numerous times over the course of history, and primarily when a particular empire no longer has the capability of dominating the world’s financial system. But unlike previous times such as with Spain, Rome, France, or Britain, the current system is not run on a gold or silver standard, which means that the reset will be much harsher to the common person since it will require a halving or worse of their current standard of living.
Central banker lets slip that Global Financial Reset is underway as government's prepare for collapse of current system…For anyone who does even a modicum of research, the 2008 financial crash was not just a cyclical 'bump' in the credit cycle, but an actual death event for the entire financial system. And this is primarily why central banks like the Fed, ECB, and BOJ have had to constantly fund their 'life support patient' with endless amounts of QE, Zero percent Interest Rates, and even Negative Rates.
In fact despite the reality of tens of trillions of dollars printed and monetized by the central banks over the past seven years in both the U.S. and in Europe, most banks remain underfunded, and pretty much insolvent if they had to administer true accounting practices. Deutsche Bank is 'technically insolvent': Expert from CNBC.
Since around 2013, Asian and Eurasian economies such as Russia, China, India, and even Kyrgyzstan have been preparing for a post Petrodollar world, and one no longer controlled by the Western central banks. And even in Europe, nations such as Germany, Austria, and the Netherlands have all done the unprecedented move of recalling their gold reserves back from the U.S. into their own vaults.
But while those who pay attention to the alternative financial media have heard numerous times that we are preparing for a great 'Global Financial and Currency Reset', only trickles of information has come from leaders on the reality of this paradigm shift.
Until now?
On June 21 the head of the UK's central bank (Bank of England) gave a speech in which he emphasized that the global financial system is moving rapidly towards a 'New World Order', which in this case is political speak for the global currency reset. The race is definitely on as to who will be dictating the terms of the reset.
Everybody has their eyes on China and Russia, thinking they join forces to form the dominance in the global economy to push out the dollar and elevate China to world reserve currency status, or elevate a combination of China and Russia to world reserve currency status with a gold and/or silver backing in this new monetary system, perhaps even with a return to gold and silver via a Chinese Gold-backed Yuan and a Russian Silver Ruble.
Well, it’s not only the East that is actively working on the global reset.
England seems to frantically be in the race as well.
Yesterday, Bank of England Governor Mark Carney gave a speech, and it wall basically all about the coming reset.
That phrase that we all can’t stand – the “new world order”.
Yup. It’s coming.
Its a very long, super boring speech, but I’ve read between the lines, and I want to show you some of the thing he has said, so that you can come to your own conclusions as to what is going on.
To me, it speaks to the end of the dollar dominated world and the coming reset and re-ordering of the global monetary system
Here’s some of the things he said in no particular order (bold and red bold added by Half Dollar for emphasis):
The Bank recognises that a new economy, a new world and new demographics demand a new financial system.
While we prepare for great change, we will be guided by one constant: our mission to promote the good of the people we all serve.
This infrastructure must be overhauled now that the economy is on the cusp of the fourth industrial revolution and our demographic challenges are intensifying.
And rebalancing of the global order is proving as dramatic as it was in Montagu Norman’s time.
Such profound changes demand a new finance.
We now have a balance sheet fit for a new world order with greater reliance on markets in a wider range of reserve currencies.
The average citizen will NEVER receive warning from either governments or the financial powers unless they are able to read between the lines in speeches such as this one on what is being worked on, and what is coming. Because all one has to do is remember back in 2008 when CNBC went out of their way to tell us how solvent and stable Bear Stearns was, only to see it vanish forever just four days later, with Congress having to push through a bailout under the guise that this crisis could bring about the institution of Martial Law. Currency war can end global US dollar dominance & those who own gold have power
The world is facing a currency war and the only hedge against the crash of the US dollar is real gold, a precious metal analyst has told RT. With geopolitical power shifting from West to East, US dominance may be ending. One such sign is the recent repatriation of gold from the United States. Countries such as Turkey, Germany, the Netherlands have been moving the bullions home. The reason is the Cold War is over and countries don’t see Russia as a threat anymore, says Claudio Grass, an independent precious metals advisor and Mises Ambassador.
“Central banks moved their gold because they felt threatened by the USSR and saw the USA as their natural ally. The fact that central banks are repatriating their gold shows that this has changed. It also implies that they don’t see Russia as a bigger threat than the USA any longer. Europe stands in the center of this geopolitical power shift and some countries obviously believe it’s wise to store the gold in their home countries,” he told RT.
The world has been living in crisis since 2008, while a currency war started even earlier, notes Grass. Central banks have been printing trillions of dollars out of thin air, while central banks are coordinating the debasing of currencies and pouring money into all kinds of financial assets, real estate and bonds.
“Nonetheless, it is obvious that the systematic problems are not solved, on the contrary, the risks became bigger and more fragile than a decade ago,” said Grass. “As you know more than 65 percent of all monetary reserves in the central banking system are held in the world currency reserve, which still is the USD. Therefore, holding physical gold is definitely the best hedge against a crash of any paper currency, and therefore also against a crash of the USD.”
The global debt has soared to $230 trillion, as the global economy has got stuck in “Monopoly-Game” system, that is based on debt and financial leverage, the analyst notes. “The last geopolitical shift that started with WWI and ended with WWII put the US in this dominant position, because they owned and stored 70 percent of the gold reserves of the free world. This was also the main reason, why the USD became the world currency reserve. For the past 30 years we can witness another geopolitical power shift going from West to East. As you know, everything operates in cycles,” Grass said.
As The Currency Reset Begins - Get Gold As It Is "Where The Whole World Is Heading"
This may be the most important commentary I’ve ever written. Here’s why.
For years, financial analysts have discussed what’s called the Global Monetary Reset, or GMR. Expectations of a GMR stem from the fact that monetary policies around the world are unstable and unsustainable.
Aftermath: Seven Secrets of Wealth Preservation in the Coming Chaos by James Rickards
There is no anchor to the system. There is no limit on money printing. There is no limit on debt creation.
Such a system grows exponentially based on the false belief that governments can spend as much as they want and central banks will pick up the tab or bail out the system as needed.
Politicians love the system because they can buy votes from their citizens. Central bankers love the system because of the power and prestige it brings them. Citizens love the system because they get handouts, bailouts, pumped-up asset values and other goodies seemingly for free.
What’s not to like?
The problem, of course, is that the system is unstable and unsustainable. It’s a huge inverted pyramid of promises poised on a small sliver of real money called gold. It’s bound to tip over and come crashing down as it has many times in the past, from the Jubilees of ancient Israel to the global financial crisis of 2008.
The 2008 panic would have closed banks and capital markets globally but for tens of trillions of dollars of central bank intervention. That bailout money printing has still not been mopped up. The 2008 bailout has sown the seeds of the next crisis.
Viewing this broadly, an objective analyst can see that a new system based on some hybrid of dollars, gold and the IMF’s world money called special drawing rights (SDRs) is inevitable. This new system could even include an encrypted distributed ledger or blockchain, and might revert to fixed exchange rates instead of floating.
The GMR would be a return to something like the old Bretton Woods system (1944–1973) but with 21st-century characteristics and technology. This is what is meant by the Global Monetary Reset.
That much is clear. The open issues for students of the GMR are when it happens and how.
There are two answers to the how part. It can either happen in a proactive way by convening a new global monetary conference similar to Bretton Woods (1944), the Plaza Accord (1985) or the Louvre Accord (1987). Or it can happen in a chaotic fashion in response to a new financial crisis, as occurred at the G-20 Washington summit led by George Bush and Nicolas Sarközy in November 2008.
My estimate has always been that the GMR would be conducted in a panic due to the lack of leadership and foresight of the global monetary elites.
The answer to the when part is necessarily uncertain, but given what we know about the dynamics of complex systems and the scaling metrics of the current international monetary regime, the best answer is probably “soon.”
In a nutshell, a catastrophic collapse is coming, probably sooner than later, and the result will be an entirely new international monetary system in which the dollar is dethroned as the world’s leading reserve currency and something new is put in its place. That’s the GMR.
What if I told you the GMR already happened and no one noticed?
Here I have to acknowledge that some of the information that follows was provided to me by a source. The work of this source is tentative and requires more independent research. Yet it looks solid enough right now to share with readers.
I’ll be writing more about this revelation in my new book, Aftermath, coming Oct. 30, 2018. You can preorder a copy here.
In Aftermath, I’ll disclose more about the origin of this information.
For now, I just want to be fair and acknowledge that it originated with an unsolicited research report sent to me from a correspondent named D. H. Bauer based in Switzerland. We’ll call him “DHB” for now.
Let’s start with a simple analysis we’ve all done ourselves and expand that analysis with information from DHB. Then I’ll provide some conclusions that stem from this presentation.
We all follow the price of gold. We think of gold as about $1,320 per ounce. We say it is “up” or “down” by $10 per ounce and so on. When we do this, we are really quoting a cross-rate between U.S. dollars (USD) and one ounce of gold (GOLD).
Let’s call this cross-rate USD/GLD.
We also follow the cross-rate between the U.S. dollar and the Chinese yuan (CNY). That’s the exchange rate between the currencies of the two largest economies in the world, which combine to produce almost 40% of global GDP.
When China instituted a shock devaluation of their currency in August 2015, U.S. stock markets fell 11% in three weeks and it looked like there was no bottom. Then the Fed intervened with a delay of the liftoff in rate hikes from September–December 2015.
China devalued again in December 2015, and U.S. stocks fell 11% again from Jan. 1 to Feb. 10, 2016. It took the G-20 Shanghai Accord in late February 2016 to put an end to Chinese shock devaluations. This recent history reveals that the U.S.-China cross-rate is one of the most important metrics in world finance.
Let’s call this cross-rate USD/CNY.
Finally, if you’re a geek like me, you take a look at the U.S. dollar value of the SDR every day. It’s not a secret; the IMF actually publishes that cross-rate daily, found here. As of this writing, SDR1 = USD1.419, but that rate changes daily like any floating exchange rate.
Let’s call this cross-rate SDR/USD.
Now, you all recall the transitive law from middle-school math. In short form it says:
If A = B and
B = C, then
A = C.
In other words, if you have two equalities, you can substitute a factor from one for a factor from another and still end up with an equality.
Here’s where DHB’s insight comes in.
He took the known quantities of USD/GLD and SDR/USD and applied the transitive law to calculate SDR/GLD.
While I think about USD/GLD, USD/CNY and SDR/USD all the time, I have to admit I never thought much about SDR/GLD.
Why would I? I don’t own any SDRs and I can’t get my hands on any. The IMF only issues them to member countries, and they’re traded among the members through a secret trading desk inside the IMF.
If I want to buy gold, I use dollars. In China, they can buy gold with yuan. The idea of buying gold with SDRs may be off in the future, but there’s no active gold market priced in SDRs today.
Or is there?
DHB took a look. What he found was shocking. It’s summarized in this chart:
Source: D. H. Bauer
The timeline along the horizontal x-axis runs from Dec. 31, 2014 to March 31, 2018. The price line along the vertical y-axis is measured in units of dollars or SDRs depending on the data series. The units run from 700–1,400.
The red line is the dollar price per gold ounce (USD/GLD). The dark-blue line is the USD/GLD trend. The green line is the price per ounce of gold in SDRs (SDR/GLD). The purple line is the SDR/GLD trend.
The black vertical line indicates the date, Oct. 1, 2016, that the IMF allowed the Chinese yuan to join the “basket” used to determine the value of an SDR. (The rest of the basket consists of dollars, pounds sterling, euros and Japanese yen.)
Here’s what DHB discovered. Before China joined the SDR, both the dollar price of gold and the SDR price of gold were volatile. After China joined the SDR, the dollar price of gold continued to be volatile, but the SDR price of gold exhibited much less volatility, especially after the first few months.
Most importantly, the trend line of SDR/GLD is a near-perfect horizontal line.
In short, world money has now been pegged to gold at a rate of SDR900 = 1 ounce of gold. It’s a new gold standard using the IMF’s world money.
There’s the GMR right in front of your eyes.
It takes a while to sink in. Why did SDR/GLD go from normal volatility to no volatility overnight? The straight-line behavior of SDR/GLD after the Chinese yuan joined the SDR is impossible without some kind of intervention or manipulation. The odds of this happening randomly are infinitesimal.
The SDR/GLD horizontal trend line after Oct. 1, 2016, is an example of what statisticians call autoregression. This only appears if there’s a recursive function (a “feedback loop”) or manipulation or if it’s presented as a fraud. This is how Harry Markopolos spotted the Bernie Madoff fraud; Madoff’s returns were too steady and consistent to be real given the volatile nature of capital markets.
In the case of SDR/GLD, we can rule out a recursive function because gold trades in a relatively free market determined by supply and demand. We can rule out randomness (statistically impossible) and fraud (the data come from public sources; no one is making them up). That leaves manipulation as the only possible explanation.
How would you conduct such a manipulation, and who’s behind it?
To peg a cross-rate, in this case SDR/GLD, you need a large floating supply of both components or a printing press to make as much as you need. Basically you conduct open market operations.
If the SDR price of gold rises above SDR900, you sell gold and buy SDRs (or the currency basket). If the SDR price of gold sinks below SDR900, you buy gold and sell SDRs (or the currency basket). By monitoring markets and intervening continually with open market operations in gold and currencies, you can maintain the peg.
There are only four parties in the world who could conduct such a manipulation: the U.S. Treasury, the ECB, the Chinese State Administration of Foreign Exchange (SAFE) and the IMF itself. These are the only entities with enough gold and SDRs to be able to conduct the open market operations needed to peg the price.
We can eliminate the U.S. Treasury and ECB as suspects. That’s because they are relatively transparent about their total gold holdings, foreign exchange reserves and the SDR component of their reserves. (For the ECB we look at the large members such as Germany and France for the data.) If either one were conducting open market operations, there would be fluctuations in holdings of gold and SDR component currencies that would appear in official reports. No such fluctuations appear, so they’re off the list.
That leaves SAFE and the IMF. Both are nontransparent. China has about 2,000 tons of gold (probably much more, but they don’t disclose the excess) and has been acquiring SDRs in secondary market trading in addition to official allocations to IMF members.
The IMF has about 1,000 tons of gold and can print all the SDRs it wants with its SDR printing press. The IMF also makes loans and receives principal and interest in SDRs. The SDRs can be traded through the IMF’s secret trading desk.
Even now, the IMF is preparing to bail out Argentina. When that happens, the IMF loans will be in SDRs. Argentina needs dollars to defend its currency, so they’ll have to swap their new SDRs for dollars. China will be a willing swap counterparty through the IMF’s secret trading desk.
That’s how China acquires more SDRs than its IMF allocation permits. Those “extra” SDRs are crucial to China’s ability to conduct open market operations in gold and SDRs.
The gold can be traded secretly through the Bank for International Settlements (BIS), which traded Nazi gold in the Second World War. The BIS is super-secret and is controlled by the same people who control the IMF.
China can also conduct gold purchases and sales for yuan or dollars on the open market in Shanghai and London and separately buy or sell SDRs for dollars or yuan. China can also buy or sell the SDR basket currencies separately as a synthetic SDR to manipulate the price of the actual SDR.
This kind of intervention by China to maintain the SDR/GLD peg might also explain the mysterious “gold slams” we see in Comex gold futures trading with regularity.
Analysts have speculated for years that China was acquiring gold in anticipation of a new gold-backed yuan. I always disputed that idea because China does not have a good rule of law. The yuan lacks the kind of deep liquid bond markets, primary dealers, repo facilities, futures contracts and other legal infrastructure needed to be a major reserve currency with or without gold backing. The yuan is a decade or more from becoming a major reserve currency
But the SDR is an ideal vehicle for a gold-backed currency because it has the support of every major economic power on Earth through the IMF.
The bottom line is that China has now pegged the SDR to gold. This is highly ironic, because when the SDR was created in 1969 it was originally pegged to gold and defined as a weight in gold (SDR1 = 0.88867 grams of gold). That peg was abandoned soon after, even as the dollar peg (USD1 = 1/35th ounce of gold) was also abandoned.
Since this SDR peg to gold is informal, it can be abandoned at any time. It probably will be abandoned because the Chinese sponsors of the peg have ignored the lessons of 1925 when the U.K. returned sterling to the gold standard at the wrong price. The result was catastrophic deflation that presaged the Great Depression.
The Chinese peg of SDR900 is far too cheap to be sustainable given the scarce supply of gold and the growing supply of SDRs. More to the point, the IMF will print trillions of SDRs in the next global financial crisis, which will prove highly inflationary.
Still, this is a historic development, and we’ll be watching it closely inRickards’ Gold Speculator. Even if the peg is unsustainable in the long run, it’s a clear short-run signal that China is betting on the SDR and gold, not the yuan or the dollar.
My advice under these circumstances is simple. Dump dollars, yuan and SDRs (if you have any) and get gold.
That’s where the whole world is heading.