By JC Collins
As with any major monetary transition, there will be a period of volatility and unwinding as the international monetary system rebalances towards the multilateral framework. The ongoing up and down of markets and valuations over the last few weeks will soon shift into debt defaults and corporate bankruptcies.
How bad this gets will depend on the political willingness to accept the larger and more macro debt restructuring mechanisms which are sure to follow on the heels of increasing volatility and political uncertainty.
One only need to look at the daily price swings for gold. A $25 daily swing is becoming common as the price of gold swings up and crashes back down again. This pattern keeps repeating throughout all markets. Commodities, especially crude, just keep grinding down further and further.
Almost two years ago I sat in a boardroom meeting and stated that our company needed to come up with a strategy to address $65.00 WTI oil. A few listened carefully, but most considered the idea of oil dropping from over $100 per barrel, as it was at the time, to $65.00 was unthinkable. When I followed up with the suggestion that we could see $35.00 oil most just moved onto other subjects.
The fact that we have blown through my bottom of $35.00 is extremely disturbing. This ongoing collapse in crude, $26.96 WTI as of this writing, is tightening political pressure on oil producing nations, especially Saudi Arabia. As I mentioned in the post The Coming Islamic Revolution in Saudi Arabia:
“It is common for companies faced with financial hardship to run as long, hard, and fast as they can for cash. There are many companies today which have employed such a strategy in this latest downturn in crude prices and increasing world-wide deflation. But applying such a strategy to a state, or perhaps a monarchy, is not something which most analysts would consider.”
The concept of running as long, hard, and fast as you can is being used by both nations and corporations. At some point, soon, many are going to crash into the wall. This will happen at different times for different entities, in different regions. But the cause and effect will remain the same across the diverse spectrum.
The end result is always further consolidation through mergers and acquisitions.
In past posts I have warned about the problem, reaction, solution dynamic which will be used to consolidate the international monetary system under a tighter multilateral mandate. The past warnings on debt saturation and contracting growth from both the International Monetary Fund and the Bank for International Settlements has contributed to the script of instability and adjustments to the existing monetary framework.
The structure of debt-management mechanisms have quietly been constructed behind the scenes. The Sovereign Debt Restructuring Mechanism (SDRF) of the IMF, and evolving Collective Action Clauses (CAC) will act to both restructure debt and increase the ability of nations and corporations to manage existing debt.
In previous posts we have also covered the derivatives aspect of this debt default scenario. High risk segments of derivatives will be written-off, while low risk segments will be restructured. A year ago, in the post The Fed and SDR Denominated Derivatives, I stated the following:
“SDR denominated derivatives will fundamentally reduce the exposure by functioning above the constraints of national fiat currencies, which are heavily influenced by the multi-trillion dollar non-sovereign dominated Forex markets. The SDR, held by sovereign central banks, will help stabilize the international supra-sovereign response required to reduce the derivatives risks and enact the unified policies.”
“The clearing of derivatives will also have to be handled in a broader multilateral framework as well. The establishment of clearing entities, or banks, perhaps with only one or two acting as the mandated clearing houses, can facilitate the reduction of systemic risk to the international monetary framework.”
“Derivative contracts that are considered high risk can be fragmented into clearable (low risk) and unclearable (high risk) segments. This disaggregation of illiquid derivative contracts will ensure the overall credit risk, or exposure, is reduced or eliminated on the cleared portion of the contract, while the risk associated with the uncleared portion is reduced in the markets.”
“The clearing house, in this case the Federal Reserve, will be accountable to provide liquidity for the uncleared “high risk” segments at valuations which are compatible with the margins of the defaulting members and contracts. This process would reduce the chances of default with the least amount of systemic risk to the broader international monetary structure.”
Such complex mechanism will be implemented in the coming months to address the growing risk of defaults and systemic instability. The waxing and waning of the markets will eventually exhaust both private and public institutions, as well as the individual investor.
Once the chorus of panic reaches a fever pitch, the mechanism designed to address the problems will be rolled out and further consolidation of banking and domestic financial markets will take place. The loss of sovereignty which will take place through this restructuring would not be possible without the heightened levels of volatility and debt defaults.
Some will be sacrificed at the altar of international monetary reform. But not all. And the goods times will return as infrastructure development in both developed and emerging economies begins to take place in the second half of 2016. The Chinese renminbi will appreciate and the US dollar will depreciate. Both will serve to rebalance the international monetary system and bring the world out of a period of deflation.
Most will not even realize that a further loss of sovereignty has taken place. – JC