The First SDR Review

Economics, FREEPOM

By JC Collins

The press release from the International Monetary Fund on June 23, 2015, covered some interesting and relevant topics which we have been discussing here.  The trend in regards to monetary reform and the multilateral transition is now beginning to align with the macroeconomic policies which are unfolding internationally.

Whether its debt relief in Greece, revaluating exchange rates, loosening of capital controls in China, and the composition review of the Special Drawing Right, the signs and markers are undeniable.

Gerry Rice, Director of Communication for the IMF, during the press briefing, made it clear that along with ESM (European Stability Mechanism) management of the Greece debt and banking crisis (which was first covered here back in Feb), there would be further debt restructuring.  How this debt restructuring would look, and what others countries would be involved, was not made clear.

However, based on the understanding which we have built up here on POM, we can extrapolate some obvious points.

One, the IMF will be involved in a more substantial debt relief (restructuring) process then what has been previously enacted amongst European nations.

Two, Greece is being used as the enter point for a more expansive debt restructuring program.

Three, we are only at the beginning of this process.

From the briefing:

QUESTIONER: That being said, the European Summit document makes it clear that an ESM request is conditional on IMF participation. How do you reconcile that with the fact that in pretty stark terms you’ve laid out that the proposals as currently constituted are just not sustainable from a debt perspective?

RICE:Again, what we’ve said is that our participation would be contingent on this balanced approach and that would require on the one hand, reforms, commitment, implementation, and on the other hand, financing and we have said pretty clearly, as you say, we feel the debt relief is required. So, again, the modalities and the process of potential IMF involvement would depend on those things.

In previous posts I have explained how certain currencies will appreciate and how some will depreciate.  The logic used was based on the balance of payments deficiencies.

Domestic currencies of countries which have a trade surplus will experience appreciation in order to make exported goods more expensive, which will help decrease the trade surplus by slowing those exports.

Domestic currencies of a countries with trade deficits will experience depreciation in order to make exported goods cheaper, which will help decrease the deficit by increasing exports.

With that logic in mind, we see the following exchange during the IMF press briefing:

QUESTIONER: The Fund a year ago said that the German exchange rate on an adjusted basis was probably 5-15 percent undervalued with the euro. What is the latest Fund view on imbalances within the euro zone and particularly on the German surplus?

 RICE:I’m going to ask you to be patient on that one because it’s precisely those kinds of issues that we’re going to be dealing with next Tuesday in the context of this external sector report, and those issues will be updated there and I’m going to point to that in terms of where you might get a more accurate up to date assessment just in a few days’ time.

This references exactly what was explained above in regards to the balance of payments deficiencies.  The German currency is undervalued, which correlates with Germany having a large trade surplus.  This process of adjusting exchange rates and adjusting balance of payments between nations will not just take place in the Euro zone, but also internationally.

Especially between the largest trade surplus country and the largest trade deficit country, being China and the United States.

The next question which is put forth to Mr. Rice involves the SDR review which is taking place.

QUESTIONER: What can you tell us about the SDR analysis and the release of the report and particularly how that relates to the Chinese Yuan?

 RICE:The SDR process, that’s shorthand for the Chinese request from the government of China, that the Chinese currency the renminbi would be included in our SDR basket of currencies. So what I can tell you, Barry, the SDR review is going along well. It’s focused on, as we’ve discussed here before, a well defined set of criteria. What else can I say? The financial market reforms in China are advancing and the renminbi internationalization is continuing. Further progress including continued development of the capital markets to increase the share of equity in bond financing will help improve the efficiency of financial intermediation.

I can tell you there will be an informal board discussion of this toward the end of this month, July, and I’ve laid out the broad timeline here before, I think you probably know what it is, that we’re expecting the formal board discussion of this issue toward the end of this year probably in November, but toward the end of the year. So, as I said, it’s progressing well. We are interacting with the Chinese authorities on this issue on an ongoing basis. There is a lot of work still to be done in terms of gathering data and before we would be in a position to make that assessment. But the timeline is pretty clear and I think the direction of travel is pretty clear.

The timeline is pretty clear and I think the direction of travel is pretty clear.  This simple statement confirms the intent and motive to include the RMB in the SDR by years end.  The mention of the board meeting on the SDR review “toward the end of this month, July”, leaves 7 days for that review and discussion to take place.

We will eagerly await the press release from that board meeting and first SDR review.  As Mr. Rise stated, the “direction of travel is pretty clear”.

With the expansion of RMB liquidity (the first BRICS Bank loan is denominated in RMB), and a reduction in USD liquidity (loans not denominated in USD), the required corrections to the balance of payments and progress.  As explained in previous posts, the real solution to balance of payments challenges will be found in the implementation of a super-sovereign unit of account, such as the SDR.

The stage is being set for this transition to take place over the next 1 to 5 years.  Here on POM I will continue to provide analytical conclusions based on the fundamentals of this emerging macroeconomic reality.  With each passing month the accuracy of the thesis and analysis presented here will be confirmed.  – JC

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