How Low Oil Prices Are Helping Re-Balance the International Monetary System
By JC Collins
The time is fast approaching when the normalization of monetary policy must coincide with the necessary adjustments to the international monetary system. Some of these adjustments have already been taking place behind the scenes with little acknowledgement or understanding of the full scope and scale of the transition.
There has been so much talk about the collapse and corruption of the international monetary system that we have failed to see the adjustments which have already been taking place. Each nudge and tweak takes place through the movement of markets and capital flows. What may appear to be happenstance is in fact a well-planned and orchestrated move to re-balance the international monetary framework.
There are five main areas where monetary reforms are focused. They are:
- Global Imbalances (trade surpluses and trade deficits)
- Capital Flows
- Global Reserve Accumulation (and diversification and substitution of those reserves)
- Financial Safety Nets
- Surveillance and Policy Coordination
The much lauded economic recovery is not sustainable unless the larger global imbalances are adjusted to account for the five areas of focus above. It will take the coordination of all countries on all points in order for the imbalances to be corrected.
The imbalances as they stand, hinder the necessary adjustments which are required to correct the imbalances themselves. The monetary policy of the Federal Reserve on interest rates is one such hindrance on adjustments, which is why the demand for action on increasing interest rates is beginning to increase, including from the emerging markets themselves.
The necessary adjustments are complex and will require a large amount of coordination. Some of the adjustments concern the deleveraging and rebuilding of private balance sheets in deficit countries. This point has largely been accomplished by QE policies.
Other areas of focus include facilitating fiscal adjustments where necessary, while encouraging consumption and reducing dependence on exports in surplus countries. This point has been well covered here through numerous posts on China’s plan to shift from an exporting trade economic model to a services trade model which will be based on domestic consumption. This is the reason for the development of massive cities in China which are awaiting the movement of rural population.
The adjustments required for trade surplus countries is different from the adjustments required for trade deficit countries. Some of these differences are found in the savings and investment rates of each, which includes the varying methods to intermediate between borrowers and savers.
The policy choices to address the challenges of surplus and deficit countries will also vary. The quality of these choices will also vary depending on the country and the dependence on those policies for the purpose of adjustments and re-balancing.
The gaps between these existing policies across the mandates of surplus countries and deficit countries are filled with large capital flows, like we are seeing as the USD strengthens and the impending Fed interest rate increases draws capital from the emerging markets and into American and European banks.
Being that monetary imbalances are best represented by the large deficiencies between surplus countries and deficit countries, it is worth spending some time on better understanding the differences and how they relate to real world economic factors.
Let’s take the collapse in crude prices and compare against adjustments which are required to re-balance the monetary system. The first thing of interest is that the largest oil exporters are also the countries with the largest trade surpluses.
The top ten oil exporters are Saudi Arabia, Russia, Iran, Iraq, Nigeria, United Arab Emirates, Angola, Venezuela, Norway, and Canada. All of these countries, except Canada (who has a trade deficit), rank in the top 20 countries with trade surpluses.
This is not surprising when we consider the dominance of oil in the global economy. But what is interesting is how the collapse in oil prices has benefited the emerging economies. When we consider that the emerging countries, such as China, India, Malaysia, Indonesia, etc.., will carry the brunt of any Fed interest rate increase, it becomes somewhat intriguing that it is the emerging countries themselves which will benefit the most from the low oil prices.
This benefit will be largely visible in Asian economies, which are the same economies which carried the weight of USD inflation now for decades, such as Vietnam. The benefits will be most realized through an increase in spending on much needed infrastructure development. The establishment of the BRICS Development Bank and the Asian Infrastructure Investment Bank (AIIB) will be used to fund these massive infrastructure projects while oil prices remain low.
China, who has built up a large strategic oil reserve, will further benefit from low oil prices by making up for slowing industrial growth and falling exports. As I’ve stated many times before, China is switching from an exporting model to a consumer based model. The low price of oil, which will support the expansion of infrastructure projects in the emerging countries, will support this adjustment, which will in turn lead to the further adjustments on trade deficits and surpluses between nations.
These infrastructure projects will use vast amounts of commodities, like copper and iron/ore, and eventually will soak up the large crude reserves which have built up over the last few years. An increase in the other commodities will begin before oil, and will likely begin in the first part of 2016, as the AIIB and BRICS Development Bank begin funding the projects.
The diversification and substitution of USD denominated foreign exchange reserves will also play a vital role in these adjustments. We are fast approaching the point where interest rates and reserve accumulation will reverse their current trends. This will mean interest rates beginning to increase, at least in developed countries, and the unwinding of USD denominated reserves into methods of funding infrastructure projects.
This is all being done in coordination, and all countries are on board with the strategy. The fact that the US has been holding out on specific aspects of reforming the international monetary system, such as the 2010 IMF Quota and Governance Reforms, will only be problematic for a short time longer. This delay and road block will not last much longer, and could very well be eliminated by the end of the year.
The majority of commodities prices are now at record lows, and considering the large development banks which are beginning to flex in Asia, an area which holds a vast amount of USD denominated assets on reserve, the adjustment of those reserve imbalances can only mean one thing for the price of commodities. – JC