SDR Negotiations – A Visual Guide (FREEPOM)

JcollinsEconomics, FREEPOM38 Comments

Export Increases and Currency Depreciation

By JC Collins

The future composition and weight of the SDR basket could fluctuate with the exchange rates of the domestic currencies which will use it as an anchor.  To fully understand how the Special Drawing Right could work as an international monetary unit which is used to balance trade between countries, an understanding of the problems with the balance of payments under the USD regime will be required.

Most readers are now aware of the Triffin Paradox which defines the imbalances which are created when the domestic currency of one country is used as the international monetary unit of account.  This is best visualized in the chart below.

US Trade Deficit vs China Trade Surplus

 

The growth of America’s trade deficit is clear to see against the increase in China’s trade surplus.  Both countries are on opposite extreme spectrums of the balance of payments and represent the imbalances explained in the Triffin Paradox.  When China, as the world’s largest exporter, accumulates ever increasing amounts of USD in its foreign exchange reserves, the United States is forced to expand the dollar supply in order to meet the demand.  This creates the large trade deficit for the US and the large trade surplus for China.

All other countries are positioned between these two in varying degrees of deficits and surpluses.  The accumulation of dollars by all countries supports the valuation of the USD against the domestic currencies of those countries, which in turn affects the exchange rates of all other currencies.  This adds to the systemic imbalances which are inherent in the USD based framework.

The accumulation of USD has also forced the American government into deficit spending programs which attempt to manage the debt against GDP growth.  But with the increased and disproportionate valuation of the USD against other currencies, America’s production and exports have progressively decreased with the increase in the trade deficit.

American goods are too expensive for the rest of the world.  This will change.

The chart below shows the rise of America’s debt-to-GDP ratio along with the growth in the trade deficit.  A depreciation in the US dollar will make American exports cheaper international which will promote manufacturing growth domestically, leading to an increase in exports.

US BOP vs Debt-to-GDP

But how do you depreciate the USD when it is used as the international monetary unit of account?

The obvious answer is that an alternative to the USD is used as the international monetary unit of account.  Another domestic currency will not function as this unit of account, as it will lead to the same challenges found in the Triffin Paradox.

A supra-sovereign international monetary unit of account is required.

The value, or weight, of the currencies which make up the SDR composition will be determined on a multitude of factors.  The important ones will be structured around the amount of currency in use, the level of trade surplus or deficit, the debt-to-GDP ratio, and the amount of exports.

Countries with elevated debt-to-GDP ratios will experience a depreciation of domestic currency as a means of increasing exports.  This will boost GDP and rebalance the debt-to-GDP ratio.  Countries which have a balanced trade (minimal deficit or surplus) but have a disproportionate debt-to-GDP ratio, such as Japan, as shown in the chart below, will require more in-depth debt restructuring.

Major Economies - Balance of Payments vs Debt-to-GDP

The best position for countries will be found in low debt-to-GDP ratios and high trade surpluses, or balanced trade.

Other factors which will contribute to alterations in the SDR composition will be influenced by the level of foreign exchange reserves held by each country.  It is indicated that these forex reserves (of which a huge amount is denominated in USD), will be converted, or exchanged, for SDR in the coming years.

This will in essence delegate domestic currency for domestic use only.  The SDR will be used to balance trade internationally, but will not be used domestically.

There has been discussions around the idea of including goods and commodities in the SDR weighting.  Though gold and oil, among other benchmark commodities, could very well add stability and diversification to the SDR, it is more likely that we could see a de facto “goods” inclusion into the SDR based on the exports of member countries.

The larger the exports of a country will mean a larger weighting in the basket composition.

The combination of goods and currency weighting, defined above, will be based on the exporting of whole goods by country measured against the currency metrics which will adjust the valuation of currencies.

The amount of forex reserves exchanged into SDR (mainly USD), will add an extra dimension of re-valuation and weighting in the SDR.  The US, being the debtor nation in such a formula, and China, being the creditor nation in such a formula, will find themselves locked in geopolitical negotiations over the valuation and shifting of such liabilities as the SDR becomes the international monetary unit of account.

The chart below details the largest exporters in the world measured against the size of foreign exchange reserves.  It is immediately clear that China tops both categories, giving it leverage over the multilateral transition.

The US, though the second largest exporter already, has extremely low, and disproportionate foreign exchange reserves.  This will change when the SDR becomes the international reserve asset and the USD is depreciated, allowing for an increase in exports.  The foreign exchange reserves of countries, now denominated in SDR, will be tied to the level of exports.

Top Exporting Countries and FER

The chart below gives us another way to view this, as it is based on the countries with the largest foreign exchange reserves measured against exports.  Here we see that Japan has the second largest forex reserves after China.  This will help them when it comes time to make adjustments to the balance of payments and correct their large debt-to-GDP ratio.

Largest FER by COuntry with Exports

Based on the information which has been simplified above, if the SDR adjustments taking place this year were based on these metrics, the weighting would look something like the pie chart below.  The multilateral transition, and subsequent adjustments to currency valuations and SDR weighting, under current conditions, works in the favor of China.

Obviously the United States will need to allow for considerable swings in the dollars valuation and a reduction in USD which has accumulated over the last 7 decades.  This does create a level of leverage for the US, but also creates a precarious situation which forces it into negotiations which may not always be approached from their best interests.

SDR Weights Based on Exporting Data 2015

The corrections to the balance of payments and the elimination of the inherent problems of the Triffin Paradox, will require the increase and decrease of exports and imports, and the appreciation and depreciation of domestic currencies.

The balance of payments chart below is a sensible guide to use when determining which currencies will depreciate and which will appreciate.

Appreciating and Depreciating Currencies

Some balancing will be required for the effective SDR can be implemented as the international monetary unit of account.  The SDR composition which comes into effect this January, will only be the first step in balancing the international monetary framework.

The Chinese renminbi will be included in the SDR and its use, and accumulation internationally, will expand over the next 5 years.  This will create “organic” corrections to the balance of payments in the lead up to the larger SDR adjustments, and weighting corrections, which will take place in 5 years’ time.  – JC

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38 Comments on “SDR Negotiations – A Visual Guide (FREEPOM)”

  1. Hello, Mr Collins. IThink it would be appreciated an easy example on how export goods weight on SDRs if it is possible. Thanks for all again.

  2. I dont know…
    You are describing all this as the world is functioning on sane people and ideas.
    I can not imagine that with all this psychpatic fuckers of politicans and bankers and oligarchs and so on yhis will come to fruitition.
    Dream on.
    We will go to hell and you know it.
    The question for me is: what is your agenda?
    Hmmmmmmmm

    1. We deal in facts and realities here my friend. The agenda is to inform and educate while avoiding baseless and inflammatory misdirection. Insanity is a human experience and exists within all socioeconomic levels. Truth is avoided by the majority while fear is encouraged and accepted.

      1. The way you use the word “truth” is very worrisome. You are subjectively interpreting an objective reality like everybody else. The very act of selecting data is interpreting. To believe otherwise is the height of pretense and arrogance.

        What is also worrisome is the need to point out that insanity may exist at all levels but the insanity at the upper echelons could destroy the world, unlike the insanity on a street corner. Right?

        1. The world will not be destroyed. People have been promoting that old fear for thousands of years. Insanity is worrisome at all levels because it is human insanity. Divisions are illusion. Insinuating I’m pretentious and arrogant does not take away from the truth that the thesis presented here has been correct for the last 19 months, and continues to be trending accurately. Information presented here regarding balance of payments and the inherent deficiencies in the monetary framework are fact. Information presented here will bring a broader understanding than the fear based drama which is regurgitated elsewhere. The alternative story-lines are becoming harder to defend. But as stated, there will always be those who refuse to accept the obvious. That is more worrisome to me than your anonymous online judgements.

          1. You’ve got a Moses-on-the-mountaintop style of presenting information, observed presently in your proclamation that the world will not be destroyed, as if you have some “esoteric” omniscience. It’s a style that takes some getting used to, that’s all. You are at once extremely perceptive and hopelessly naive. It’s hard to reconcile whether that naivety is real. It’s less about matters of fact than of tone and perspective. Allow me to put it this way: after reading your earlier writings of last year I would say that your intentions are not forthcoming. Sincere people state their intentions straightaway without ambiguity. People with your level of insight don’t just start posting their thoughts on the internet. So, please tell me, what is your intention here? I hope my aggressiveness is not off putting.

          2. My “proclamation” that the world will not end is based on the fact the it never has. We are here. Pretty obvious conclusion. Economics will not destroy humanity. Economics will continue to transform and adjust, as economics are an extension of the human survival instinct.

            My intentions are extremely forthcoming. Your inability to accept them are an externalization of your own conscious orientation and predispositions.

            I’m nobody special dude. I lived with my insights, mainly the esoteric ones, for many years and finally had to start writing.

            My intention is to explore the esoteric aspects of reality and the pattern that weaves through all things, including economics. Are you able to accept those intentions?

          3. You’re an interesting guy JC Collins.

            But stating that the world will continue because it always has is the same flawed logic as saying a cedar tree will keep growing because it always has. On the very tenuous presumption that “economics” will determine our future, consider this. After ten years of Keynesian militarism Germany’s war economy at full capacity either had to go to war or begin collapsing. America’s economy, controlled by a military industrial complex, is at the same crossroads after sixty years of precisely the same lunacy. Simply showing the charts of trade imbalances tells us nothing of what the future holds. The realpolitik decisionmaking is being made in the context of the overarching cycles of resources depletion and population explosion. Economics is a pretense.

            That said, JC Collins you are a breath of fresh Canadian air for this American, and I’m glad you decided to throw your ideas out there. Under this facade of Irish cynicism I’m as hopelessly naive as anyone. And that’s what scares me. I want to believe.

          4. wow, this is an intense discussion. Good on you both for speaking your minds and not taking anything personally.

            Thanks again for the insights JC

  3. In support of everything that JC has told us and the education we have received because of his time, thought and energy. He educated all of us here about these events months and months ago. I am more than appreciative of the education/information I have received on this site.This is an excellent overview of everything you have been telling us for quite a while JC.

    http://www.foreignpolicyjournal.com/2015/07/14/brics-development-bank-an-instrument-for-globalization/

    1. Does the fact that JC is a macroeconomist tell any of these people anything? This is what he does. Has he ever said that he knows everything, not even once. He does what he does well. He gives the facts as he sees them and comes up with the conclusion.

      And btw I don’t believe the world will come to an end either and neither will mankind. The logic that it will end is what is flawed.

  4. “Dream on. We will go to hell and you know it.”

    This is a pretty strong stance. Heck what if were already in hell, just hell isn’t what we have been told all our lives?

    What if we are like a seed in the dirt and it’s our purpose to grow and seek the light like a tree.

    Yet “I don’t know…”

    We all find what we seek. I think Mathew said something to that nature somewhere in his book.

    But don’t worry friend we will be here when you are ready to see. And we won’t judge you when it all comes to be.

    JC thank you for providing the foundational knowledge for which I can create my peace of mind. It is wealth beyond all this material stuff:)

  5. Hello JC and thanks again for your work. On one of your recent posts you made a statement that if China’s currency was added to the SDR basket AND China depegs from the USD later this year there would be immediate and profound effects on the US ability to deficit spend (hope I didn’t get any wires crossed). Do you have any other info if China is actually going to depeg from the USD this year?? Thanks.

    1. That is correct. There is no new information but lots of speculation. The lead up to October should be interesting. SDR, China, and US debt ceiling debates should provide some excellent popcorn opportunities.

  6. JC, just wondering if you foresee the SDR allocated currencies being reviewed every 5 or 10 years to adjust for the increase or decrease of exports in the coming years. For example, when the US does increase exports over the next 10 years, based on your analysis, wouldn’t they gain a larger piece of the SDR pie over time? If so, wouldn’t this then put the USD in a situation of value appreciation?

    The dollar and US inflation will still be exported while countries increase their use of the SDR.

    1. I would envision the valuation having real time adjustments with the currencies included being considered yearly or quarterly. This will facilitate the transformation of the SDR into the bancor.

  7. Hello JC,

    I am a months-long lurker, and always astounded by the knowledge and understanding of you and the frequent posters here. I think I have a grasp of what the coming months mean internationally, but what will it look and feel like at home? (I am in the US.) What change will I feel at the grocery store, gas pump, etc.? Like many in the US, my family is in too much debt, and I am frightened by my poor understanding of what it will take to survive what is to come.

    Thank you,

    Donna

    1. Hello Donna, I am not a professional advisor, but common sense dictates that it is prudent to be as productive as you can and pay off debt at a steady pace, while retaining a basic level of comfort.

      Productivity doesn’t nessecarily mean a paid job. It can also be serving your community or family. It is anything that increases the level of comfort for anybody through work.

      Worrying about the future will surely not have any positive effect. So be practical and regain your innate natural confidence. Stand straight and walk straight, then there’s nothing to worry about, in whatever situation you will find yourself.

  8. Donna, just continue to follow JC, you will learn. Go through and scan all his information and then take the ones most helpful and read them through. Of course JC, when he has time and can will answer questions.Welcome to our group.

  9. The future has the potential to be hell on earth or it can be a sensational opportunity to unite humanity and create a Golden Age. Before what we are told is the beginning of man existed a previous Golden Age’s. We are walking a fine line. JC I read your descriptions as a ray of hope. I do not things can or ever have nor have ever gone according to plan. And that gives more hope to a better future. One with new technology’s that will solve many problems we face.

    With so much trade deficit and debt is there any hope that Government’s with so much debt will be able to fund infrastructure projects?

    Or is it more likely Governments will increase is size and the number of laws hunting every tax dollar they can ?

    Private companies will only invent new technologies that are then sold to Governments due to these control methods for tax dollars. This will ultimately lead to disintegration. Second Law of Thermodynamics! Grass roots projects will emerge from the unemployed and fed up. So it seems the struggle before us will be drawn out for some time. So many potential outcomes that depend on the character of strong individuals to carry the load of for those who have lost their way. You have added to the strength of character.

    1. There will be a new cycle of liquidity, as there has always been. That will fund the infrastructure projects. I appreciate the vote of confidence my friend.

    2. Hi dripfood, I am intrigued by your statement that “Before what we are told is the beginning of man existed a previous Golden Age’s”. What do you mean by that an where did you gain this knowledge? When these topics come up, I am loathe to admit my lack of learning in these areas, but am fascinated. Another reason I am looking forward to more of JC’s posts in Esoteric, Primnomics and the Grand Man. Thank you, Donna

      1. The second installment of The Grand Man (ironically subtitled “The Before the Beginning”) will be up in a day or two. Pending any other sudden commitments. And the subject matter will weave into the content of PrimNomics – The First Division. It’s the more personal subject for me, and is challenging to write at times. Hopefully it’ll be worth the wait.

        1. Thank you, JC,

          I have been drawn to your writings. They have opened up a whole new world to me, along with the comments of dripfood, speedspirit, Dane, Jeremy and many others… I feel my soul is hungry for wisdom beyond the macroeconomics which you have explained so well. I try to talk with friends and co-workers about the topics discussed here and I get the “deer in the headlights” look, or a “wow” and then they go back to their day. I look forward to your second chapter of The Grand Man, and much more. As Dane said, I feel “… we are like a seed in the dirt and it’s our purpose to grow and seek the light like a tree.” I know I’m just starting to look up, and it’s an amazing sight.

          Donna

          1. Eternal perfect knowledge and conscious thought are mutually exclusive

            If we could access perfect knowledge we would not need to think consciously. Imperfect knowledge forces us to reason and make choices

            Purpose is a set of beliefs one adopts in order to define and rationalise the choices he/she makes. Purpose is a human creation, and a result of conscious thought

            Purpose cannot exist in a world of perfect knowledge. The only purpose is that which we conscious minds create based upon imperfect knowledge.

        2. “Hopefully it’ll be worth the wait.” It always is my friend. And it allows us the opportunity to work on the virtue of patience. Are you done yet! Lol. Guess I have some work to do in that area:).

  10. Is because this new cycle the new financial system will be corrupt too, as you said in others posts? I undestand that projects should be profitable if not we will have anothe bout of debt soon. I do not need answer if it is yes.

    1. Susan, I don’t even know what the “dismantling of the Western system” means. Sounds like more goobbly-gook talk from the sky is falling crowd. If by “Western system” they mean the USD based unipolar monetary framework (Bretton Woods) then I would say no. The world is making concerted efforts to transition this system to a more balanced framework, but “dismantling” is another one of those emotional buzz words which doesn’t accurately state the real conditions, or events. Volatility will be an integral part of implementing components of the multilateral transition. This volatility will be everywhere, like in China’s equity markets right now.

  11. Hey guys thought this might fit in here pretty good.

    “Export-Import Bank could be revived via highway funding bill”

    http://www.latimes.com/business/la-fi-export-import-bank-20150717-story.html

    Its interesting that EXIM’s website has this on the front page.

    “Due to a lapse in EXIM Bank’s authority, as of July 1, 2015, the Bank is unable to process applications or engage in new business or other prohibited activities. For more information, please click here.”

    http://www.exim.gov/authority-has-lapsed/

    And the “Fact Sheet” from the White House.

    “FACT SHEET: The Export-Import Bank: Supporting American Exports and American Workers in Every State Across the Country”

    https://www.whitehouse.gov/the-press-office/2015/06/30/fact-sheet-export-import-bank-supporting-american-exports-and-american

    And a little old Cuba news about their super port and free tax zones to add to the newly rekindled ties between the US and Cuba. Is China the only country making those super size transport ships?

    “Cuba: Port Upgrades and Free-Trade Zones”

    http://www.americasquarterly.org/content/cuba-port-upgrades-and-free-trade-zones

  12. Hi JC,

    Loved the thread above with grs, good dialogue there.

    Here’s a Washington Post article on trend with American manufacturing coming back to US:

    Wal-Mart’s self-interested shot at reviving the American factory

    “We’re just not getting millions of manufacturing jobs back unless we get much closer to balanced trade — and they key to that is currency,” says the left-leaning Economic Policy Institute’s Josh Bivens. “Everything else is tinkering on the edges.”

    FULL ARTICLE:
    http://www.msn.com/en-us/money/companies/wal-mart%e2%80%99s-self-interested-shot-at-reviving-the-american-factory/ar-AAd53Tm

    1. Thanks Jennifer. That’s exactly what I mean when I state the trends are clear. When we fully understand the imbalances in the system, and what has caused them, there is really only one solution and path forward. The pieces quickly begin to fall into place. Unfortunately so many are still attracted and distracted to the silly noise which brings zero understanding.

  13. Thanks JC always good to see your.perspective and knowledge, helps keep things grounded from the the rest of the information/disinformation out there, giving a down earth view, I’ve learned quite a bit from reading your essays, thanks from down under

  14. Hi JC. I would love to get your thoughts on the inclusion of gold in the new SDR structure I have read in your previous posts that you see that as a possibility. Many of us are seeing the evidence of the manipulation of the gold price via the paper markets and we are all wondering who exactly is behind this. Is there an advantage for the institutions to push the price of gold as low as they can before it is included in the SDR basket. So to rephrase my question: What are the benefits of having gold included in the SDR basket at the lowest price possible?
    Would love to get your thoughts on this.
    thx

    1. There are few things surrounding gold lately which are puzzling. The drop in value is not surprising, as I’ve openly stated I felt that was going to happen. More puzzling, as many other analysts have expressed, is the announcement of China’s gold reserves. I have always felt that China would place a large amount of gold on deposit with the IMF to increase the RMB position in the SDR. Introducing gold into the SDR at a low level will help expand SDR liquidity when gold increases in value once again. You’re on the right track with that line of thought.

      Perhaps the low amount of official Chinese gold is the dead giveaway of what is about to happen. The amount of gold which has been moved around the world in the last few years doesn’t happen without the consent of all the big players.

  15. I have been wondering about the Chinese announcement as well. Two thoughts on that matter. It may be a warning shot in the direction of the US (congress) to ratify the 2010 I.M.F. Code of Reforms or they don’t want to create a shock in the financial markets and are planning to release information about theit total holdings step by step.

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