By JC Collins
After the financial crisis back in 2008 monetary and fiscal planners around the world became increasingly concerned about the effects of the Triffin Paradox. The large accumulation of US dollars in the foreign exchange reserve accounts around the world forced discussions on dollar alternatives and paths forward which could be taken to rebalance the international monetary framework.
The two major players in these discussions were the United States and China, both of whom play opposing and diametric positions within the international system, with the International Monetary Fund acting as the pivot point.
This emblematic relationship between the United States and China is reflective of the imbalances in the international monetary system. China has consistently grown large surpluses year over year and has achieved the same with its foreign exchange reserves. A large percentage of these reserves have been invested in US Treasury Bonds.
For America’s part, large and persistent current account deficits have contributed to the growth of substantial foreign debt. Trump recently discussed this in his Indiana victory speech by repeating the phrase “debtor nation”, driving home the point to the American people that something has to change.
In essence, developing, or emerging nations are transferring reserves to the US and other industrialized countries. This money is lent at low interest rates which allow the developed nations to live beyond their means and import for mass consumption.
The problem with this monetary system is that creditor nations, like China, become increasingly worried about the large investment they have made into the US dollar. Future loss of dollar value and a lack of alternative liquidity on a global scale have forced the majority of the world to side with China and other BRICS nations to seek a new framework through the IMF and the broader use of the Special Drawing Right.
The United States, now a debtor nation as Trump stated, has no choice but to relinquish control and power to a growing international consortium of concerned countries and institutions. The large debt leverage which the rest of the world holds over America has forced a reluctant US government and Treasury department, along with the Federal Reserve, too enact monetary policies which are driving towards this ultimate rebalancing.
The International Monetary Fund will be the driver, and the SDR will be the vehicle. China, the representative of all emerging nations, is providing the fuel. But the large amount of US debt held around the world also gives America some bargaining power, which is why the necessary adjustments to the system have dragged out for years since the financial crisis.
Some obvious geopolitical checkmates have developed and the position of the US as the sole superpower in the world has been forever compromised.
In order for there to be an alternative multilateral monetary framework based on the SDR, some fundamental changes had to take place.
- The composition of the SDR basket had to change and the Chinese renminbi would have to be added. This has been completed and the new composition comes into effect this October.
- Reform of the IMF. This has been completed with the implementation of the 2010 Quota and Governance Reforms.
- An increase in SDR allocations. This will be forthcoming once the basket composition is put into effect.
- Large issuance of SDR denominated bonds. This is also forthcoming with both China and the G20 stating that SDR denominated bonds are on the horizon. The People’s Bank of China has communicated their intent to issue these bonds.
The IMF and the G20 are currently working on a plan to broaden the use of the SDR, which will include the above items, two of which have already been implemented. The other two will happen in a short period of time.
This will all likely take the form of an open-ended SDR denominated fund which will allow for convertibility between SDR and the reserve currencies in the basket. This will require IMF member countries to entrust a large portion of their foreign exchange reserves to the IMF. These reserves will be managed through a centralized process based on the open-ended SDR denominated fund.
Transferring large portions of foreign exchange reserves to the IMF is problematic on the domestic level. It amounts to a loss of sovereignty by member nations. Each country will address this issue differently, but there will be a need to sell such a program to the masses through a type of nationalism, such as Trump is doing while campaigning for the Presidency in the US.
China, and other BRICS nations, have America over a barrel. The accumulation of US dollars and the large US debt load has created the situation required to consolidate the international monetary system further and reduce sovereignty. The US has some bargaining power but the dye has been cast.
China was the first one to suggest a broader role for the SDR and the IMF, and its movements today are indicative of the continuation of that methodology. This is very reflective of why both China and Russia, along with Iran, are taking such prominent positions within the geopolitical world. -JC