A Part of the Solution to the Problem of Global Growth
By JC Collins
Over two years ago now I began a series of articles titled SDR’s and the New Bretton Woods. The ten post series focused on the SDR and its eventual evolution into an internationally traded asset. There was very little information out there at the time on this future transformation of the IMF’s Special Drawing Right currency, and POM broke new ground on many of the facts, trends, and methodologies behind the transition to a multilateral monetary framework.
Each month more and more information and confirmation of the POM thesis emerges which further validates much of what has been presented to readers for over two years. The latest validation comes from the G20 Communique from last weekend’s summit in Shanghai.
Item 11 under Issues for Further Action states the following:
“We look forward to the IMF's report to examine and reflect on the possible broader use of the SDR by July.”
This one statement provides the largest validation yet for POM readers that we are in fact on the correct course with this thesis. What isn’t clear in the statement is whether July is the deadline for the report to be presented, or when the broader use of the SDR should begin. Considering the time it takes to decide on changes and implement them, it would be my interpretation that it is only the report which is meant to be completed by July.
What started as a recreational analysis on the Federal Reserve, China, and a new monetary framework, has morphed into a full time obsession which has defined a new path in my life. The evolution of my understanding and comprehension surrounding this transition has increased by hundreds of multiples. Presenting this information to the tens of thousands of readers out there who are interested in such things has been one of the greatest honors of my life.
But it is now time to increase awareness on both the SDR and the multilateral transition itself. Which is why I recently started another series titled The Fundamentals of Multilateral Investing. The lessons in this series will increase understanding around investing and markets, and provide the know-how to apply those learnings to both comprehension and utilization of the emerging monetary framework and its associated markets.
One aspect of the SDR transition from IMF book keeping unit of account, to becoming a true internationally traded asset and unit of account used in banking and finance, is the much used concept of problem/reaction/ solution.
This Hegelian Dialectic had been discussed here on POM relentlessly in the first year. The second year I focused more on the actual details and methodologies which would define and determine the path of the transition.
Two years ago we reviewed how the problem of global deflation and contracting growth would be used to promote the concept of a large issuance of SDR denominated bonds. The reaction to this contraction in global growth has now been unfolding for some time. The recent POM article titled No G20 Stimulus Sets the Stage for Structural Reforms does a good job of summarising this reaction and clearly interpreting what the G20 Communique was really about.
It has always been a major part of the POM thesis that the monetary policies of low interest rates, quantitative easing, and other stimulus measures were only temporary responses to the deflationary dollar crisis of 2008. U.S. monetary authorities led the charge down the stimulus path and are now leading the charge back to monetary policy normalization.
As the G20 communicated last weekend, stimulus is now off the radar and the next phase of structural reforms will need to accelerate. Some of the reforms involved the 2010 IMF Quota and Governance Reforms, which is one of the first things we began discussing back in January of 2014. These reforms have now been passed.
Another aspect of what we had previously discussed was the inclusion of the Chinese currency in the SDR basket composition itself. The effective date for this new SDR is this October.
We have also previously discussed the use of IMF Substitution Accounts to facilitate the issuance of SDR bonds and act as a tool to diversify and substitute USD denominated foreign exchange reserves with SDR bonds. This will likely be a major component of the G20 report on broadening the use of the SDR.
To make all of this work, banking and finance must accept and adopt the SDR as a unit of account. Financial instruments, or intermediaries, need to be further developed and implemented in order for this concept to gain ground as a viable partial-solution to the problem of contracting growth.
A framework needs to be created where SDR liabilities can be matched against SDR deposits. This would entail a greater private use of SDR as a unit of account and lead to its enhanced role as a reserve asset in the international monetary system.
It can be expected that at some point in the near future, perhaps before the end of this year, the International Monetary Fund will address the problem of slow global growth with a large issuance of SDR bonds. I would encourage readers to thoroughly read the past material here on POM as this strategy has been well reviewed.
But don’t think for a second that the SDR is going to replace the US dollar as the reserve asset any time soon. This will take years to develop and in the meantime there will be a functioning multi-currency reserve system which is based on the dollar, the euro, and the Chinese renminbi. That was the importance of having the RMB included in the SDR for this year.
The forthcoming large issuance of SDR will likely be connected to Chinese’s large foreign exchange reserve position. The transfer of USD denominated financial obligations through substitution accounts will facilitate the transition from stimulus to structural reform.
The international use of SDR bonds to increase global growth will only act as one part of the solution. There are many other changes which need to take place. The gradual replacement of national currency liquidity with SDR liquidity will take years. The issuance of SDR bonds will increase incrementally in parallel with the expansion and implementation of negotiated structural reforms on a region by region basis.
Some nations will embrace structural reforms immediately while others will drag stimulus out for a short while longer. But the transition points are clear and coming more into focus with each passing month.
I should also make it clear that I am only explaining and describing the process and methodology which is being used to correct global imbalances and promote growth in a multilateral monetary framework. I am not promoting such a system, merely describing it, because the reality of the transition from the unipolar USD based system to the multi-currency based system can no longer be denied.
Over the last two years I have been attacked and marginalized by so many who said nothing of the POM thesis would ever happen. The fact that most of the predictions have become reality, especially those around the BRICS institutions and the Chinese currency, should solidify the trend in the minds of most.
Once we accept that this is the path which the international banks and institutions are taking, the sooner we can position ourselves to reduce risk, minimize losses, and maximize gains. Sitting back and moaning about corruption, market manipulation, and using every negative news story as the proof that the whole system is about to crash will not provide the understanding which is required to traverse this monetary mind field. - JC
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