By JC Collins
There are increased discussions taking place between the G20 finance ministers and central bank governors that a decision should be made at this weekend’s meetings in Shanghai to depreciate the US dollar against select currencies. The meetings, which are being held on February 26th and 27th could very well signal the beginning of the exchange rate transition which we have been reviewing here on POM for the last two years.
As we have thoroughly covered, the increasing global deflation and slowing growth would act as the monetary and financial catalyst to spur the economic reforms and promote the required monetary policy changes to support the multilateral framework. This is exactly what is now taking place.
This shift away from the unipolar USD framework is meant to correct global imbalances and promote economic growth in all nations and regions. The strengthening USD over the last year has put increased pressure on the emerging nations, such as China.
But we must understand that this pressure exists for the simple reason that the emerging nations are the ones carrying the bulk of USD denominated debt. This debt has accumulated in the foreign exchange reserve accounts of these nation’s central banks. In simple terms, the emerging nations have become large account balance surplus countries while the US has become a large deficit country.
It is this imbalance which the G20 group is mandated with correcting. Outside of reserve diversification and substitution, the other method of implementing a transition is to evolve the existing exchange rate regime which is based on US dollar dominance.
Some analysts are expecting that the G20 will not reach an agreement on this issue because the US has been experiencing positive growth. The problem with the conclusion involves the contagion issue surrounding the interconnectedness of the international monetary system. The increasing pressure on the emerging economies will spread to the western institutions and the world will fall deeper into economic contraction and enhanced volatility.
The other aspect which needs to be considered is that American monetary authorities in both the Federal Reserve and the Treasury would welcome a depreciation of the dollar against the currencies of its largest trading partners.
We have also reviewed that aspect of the monetary transition here on POM. A dollar depreciation of 20% to 30% against other currencies would see American exports become more cost effective for other nations. This increase in exports would translate into more domestic factories firing back up and would increase jobs. The jump in GDP would serve to reduce the overall debt-to-GDP ratio of America.
In essence, a depreciation of the dollar would serve the monetary and financial goals of the United States.
Furthering the idea of a dollar depreciation in the upcoming G20 meeting, analysts at TD Securities have suggested the following:
“While we think a formal G20 currency intervention is unlikely, odds are rising that some form of statement is released acknowledging currency misalignment and stating that countries are “monitoring exchange rate developments.”
“We’re already seeing more vocal questioning of the adjustment of currency markets from the Fed’s Yellen, BoJ’s Kuroda, PBoC’s Zhou, and RBA Deputy Governors, as well as action from Banxico & Bank of Korea that is consistent with a weakening of the USD against some–but not all–currencies, which could boost commodity prices.”
The boost in commodity prices would also fit with another aspect of the POM analysis, which is based on a forthcoming commodities boom as broad investment in infrastructure development takes place in all nations and regions.
The Asian Infrastructure Investment Bank and the BRICS New Development Bank are set to issue the first development loans for emerging nations later this year. The AIIB has stated that it will issue USD denominated loans as it does not intend to use the institution as a means to overthrow the prominence of the USD.
Perhaps this has been negotiated as an overall part of any currency discussions. The reign of the USD will not end anytime soon. The need to diversify foreign exchange reserves is apparent. But a replacement of the dollar on the global stage is not in the workings of the G20 and international institutions, such as the IMF and BIS.
The intent is to build a three-way multicurrency system based on the USD, the Chinese renminbi, and the euro. All three will work towards the goal of stability in the international monetary system. This multicurrency system will eventually develop towards to the SDR supra-sovereign asset methodology of the International Monetary Fund.
In the meantime, whether the G20 acts this weekend, or simply sets the stage for action later in the year, the path forward has been defined. A depreciation of the dollar would be a major analytical win for the POM thesis. When added to the correct predictions which have already been made, the end goal of the multilateral transition should be solidified in the minds of most readers. – JC