The Constitution of the SDR
By JC Collins
Reader Adam commented the other day with an interesting question. Such questions at times become the basis for a pointed post because it makes more sense to use this format as opposed to a simplified response in the comments section.
In the run up to the reconstitution of the SDR, I would have expected increased volatility. I think you have suggested as much in previous posts. Yet it seems like just the opposite is happening.
Are you as surprised by the remarkable decline in volatility as I am?
Not surprised at all. In fact, after the last batch of market volatility earlier in the year I stated that things would be better for a while but new volatility would come. There is the likelihood that the next sequence of volatility will cause deeper issues and require the response which will demand the broader use of the SDR.
We need to remember that the need for a broader use of the SDR is based on the systemic imbalances which cannot be corrected without a change in the framework of the system. Given the general acceptance of the SDR within the G20 nations, and its tabled interest at the upcoming meeting on September 4th and 5th in China, we can assume that the path forward on implementation, and as you stated “reconstitution” of the SDR, is purpose-directed and well thought-out.
The need for enhanced levels of volatility will re-enforce the scripting that has been, and continues to be, put out strategically by vested interest. Such a script has once again been put forth this past week when Deutsche Bank proclaimed the following:
The conclusion is that without an external economic shock it is hard to see policymakers being prepared to take dramatic, fiscal action to jumpstart the global economy and bounce it out of a financial repression defined by low and falling real yields to one that at least initially is defined by rising nominal yields through higher inflation expectations. Ironically the shock that is needed would require a collapse in risk assets for policymakers to then really panic and attempt dramatic fiscal stimulus.
The logic would also fit with the same correlation structure for financial assets – a un-wind of the falling yield/rising equity market where all financial assets trade badly. In other words the end of financial repression will see price levels fall so that yields once again look attractive. For such a move to be sustainable itself requires the economic fundamentals to shift – inflation needs to be more secure against an underlying backdrop of robust real growth. Most people now understand that this is not a job for monetary policy alone. Yet the current reach for yield simply prolongs the status quo for policy disappointment.
Such statements follow a similar scripting and pattern which has been put out from the Bank for International Settlements regarding the likelihood of enhanced volatility in the financial systems. This is just a continuation of this scripting.
It is probable that during the fall political season in America, or after the conclusion of the election, sometime in the 2017, we may see increased volatility. I know this isn’t as time specific as some would like, but it is difficult to point specifically to a period of weeks or months.
Once the G20 meeting has taken place and the new SDR constitution has been implemented this October, the world will shift into the US election drama. The threat of Trump has already been discussed related to a devaluation of the dollar, should he win. This could very well be the script which is followed.
Any devaluation in the USD would cause market volatility for a short period of time. The level of instability would depend on the speed at which the world can implement alternatives to relax some of the pressure related to the use of the dollar.
Though things may appear stable during the dog days of summer, let’s not be fooled into thinking that the volatility will not come. But also keep in mind that the volatility which I discuss is in no way meant to represent a full on market crash or collapse of the dollar. It will be just the right amount of instability to demand acceptance of a broader use of the SDR and a level of supra-sovereign monetary policy across the international monetary system.
Based on the fact that the G20 nations and emerging nations are all demanding this broader use, and the integration paths are, and will continue to be, defined in advance of the volatility, the transition to the new framework may not require as much instability as any of us would have expected.
Deutsche Bank’s reference to “an external shock” is a well-placed statement which can achieve the same objective. The threat of an “economic shock” can be just as effective as the realization of such. In all likelihood there will be a combination of real threat and perceived threat which has been built up through strategic scripting. – JC