Also see updated information in today's post titled Potential Path Forward on Fed Rate Increases - Sovereign Wealth Funds, Reserve Diversification, and Capital Flows
But Dreams of a 2015 Rate Increase Remain
By JC Collins
With the announcement by the Fed today of no interest rate increase, the hopes and fears of a September crash recede into the background noise from which they came. What we can expect is the same slow grind of deflation and modest volatility leading into the fall and winter months. Though nothing the Fed said today would indicate that a rate increase is off the table for 2015, and could still take place in December.
The international demand on the Fed not to raise rates was coming from all sectors and regions, including the Bank for International Settlements, IMF, World Bank, China, and various other central banks and institutions. With a level of domestic justification for a rate increase, quantified by previous Fed statements on inflation and employment levels over the last few years (all of which have been reached), it can be assumed that the lack of international justification and support influenced today’s decision.
With the restructuring of the international monetary system high on the agenda of the global institutions, it is probable that the decision by the Fed today is signaling that the US is in fact willing to negotiate and facilitate the development of reforms.
The deadline for the 2010 Governance Reforms has come and gone with little fanfare. The framework of Plan B reforms is scheduled to be determined by Sept 30, and implemented by December 15th. This timeline would correspond with the next FMOC meeting and decision on rates.
The announcement on the Plan B framework could be announced at the IMF and World Bank meetings in Peru next month.
In that time we can expect for there to be further diversification of reserves, especially from China, and an increase in this diversification from the European Central Bank. But the real diversification and substitution will have to take place through an agreed upon framework and implemented before the Fed raises rates.
This would further suggest that the Fed is working alongside its monetary partners on reform, and the delays on the 2010 Governance Reforms is the catalyst for the restructuring.
The diametric opposition presented by delaying IMF reforms, which works counter to international demands, and delaying interest rate increases, which supports international demands, would strongly suggest that the diversification of USD reserves around the world is supported by all interested parties.
The balance between managing inflation and increasing interest rates is challenging, in that if the Fed increases rates too much and too soon, the pressure on the emerging economies, such as China, to speed up the rate of reserve diversification will intensify. This accelerated reserve diversification will mean a flood of USD coming back into America, causing higher levels of inflation, which in turn would mean the Fed would need to increase interest rate even further and harder, which would cause even deeper reserve diversification.
The point of international monetary reforms is not to eliminate the USD all together, but to simply balance the surpluses and deficits between the major players, and diversify the reserves to more fairly represent the economic realities of the world.
As such, the dance of interest rates, reserve diversification, and exchange rates will be sporadic and random, like a piano tango between mismatched pairs. The delay in interest rate increases by the Fed is extremely promising in that it suggest they are willing to work towards stabilizing the international monetary system, and working towards the meaningful restructuring which is required.
Perhaps the transition from the unipolar dollar based system to the multilateral system will not be as harsh and destructive as some of us have considered. - JC
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