And What Could Help Stabilize Stock Markets
By JC Collins
Last night Marianne and I were watching Donald Trump on television give his speech in a Dallas arena filled with 18,500 people. Along with his usual script of “making America great again” he said that there is $3 trillion outside the country which he will be bringing home. We both looked at each other and mouthed the words “what the %$&@!”.
The statement appeared to slip past unnoticed, and it was not referenced or discussed by anyone after the fact.
It is very clear to me that Trump is reading from the same script as the macroeconomic transition to a multilateral monetary framework which has been widely presented here. The diversification, or reduction, if you will, of Treasuries in the foreign exchange reserve accounts around the world, and the overall depreciation of the USD, will all amount to increased US exports and domestic production.
This means more factory jobs and a growing economy. Making America great again, as Trump keeps repeating.
But what about this $3 trillion? Could this be a reference to the reserves which will be diversified and sent back home, or transferred into the coffers of the IMF, making that institution the largest holder of US debt? Could the US see this money come back home through new IMF SDR allocations and adjusted quota amounts?
What is certain is that as the demand for the USD decreases, as it will in a multi-reserve system, the currency itself will depreciate. This depreciation will make American goods cheaper to the rest of the world, and increase exports, domestic production, and jobs.
But what about all that money coming home? And why will it come home?
Trump is selling a script of what will happen down the road in a manner that re-enforces the positive. At one point many would have considered $3 trillion coming back home to be the cause of hyperinflation and should be avoided at all costs.
So why such a cavalier approach and casual delivery of that specific statement by Trump?
Let’s answer those questions by first discussing the Federal Open Market Committee (FMOC) and its announcement on interest rates this Thursday. While many analysts are predicting that the Fed will not raise rates, and in fact can never raise rates without crashing the whole system, I propose that they will in fact raise rates, and will, in all probability, raise them for the first time this Thursday.
If they do not raise in 2 days, they will raise in October and/or December. Either way it is coming.
All central banks, global institutions, and emerging markets, like China, are asking the Fed not to raise rates as it will put pressure on their currencies, and slow global growth for everyone. But like the 2010 IMF Reforms, the US will not agree with the rest of the world, and will continue on its own path of monetary policy normalization and “making America great again”.
What very few are considering is that raising rates will drain USD liquidity from the international financial system by causing the type of volatility that many are using as the reason why they cannot raise rates. The intent is to “crash” the system, or more reasonable, as stated above, drain dollar liquidity from the system.
The pressure that a rate increase will produce on all countries and regions will manufacture the need and political support required to set off a scramble out of dollar reserves, as central banks attempt to remain liquid and support currency valuations.
This will shatter the existing USD exchange rate arrangements and cause severe forex volatility. Such a sudden shift in reserve composition will increase liquidity in other markets, such as the euro and yuan.
This large scale shift in dollar reserves will force the Fed to increase interest rates even further in attempts to support the waning dollar exchange rates and limit the imported inflation which would follow such a sequence of events.
The other part of this diversification of reserves is what will replace the dollar reserves. We are likely to see an increase in euro denominated reserves as well as an increase in Chinese renminbi reserves. But keep in mind that the USD will remain as a pre-determined percentage of all reserves.
The dollar is not going away.
We could see Asian and Latin American central banks shift reserves into the renminbi, but also into other real assets, such as purchasing equities through sovereign wealth funds. This could help balance stock markets from the volatility associated with these structural changes.
There will be a marginal increase of reserves shifting into gold for the main reason that gold is too high in value (contrary to what many others profess) and is not widely considered a reserve asset.
Now, before anyone gets excited, I’m not saying gold shouldn’t be a reserve asset, or won’t be used as a reserve asset down the road, I’m only saying that it isn’t considered a reserve asset by the central banks and international institutions. Even though they like to accumulate it.
The idea would be to limit the negative effects on the USD, as well as euro, as the emerging economies diversify their reserves, while maintaining a level of dollar reserves.
With all of that being said, there will be an influx of dollars returning home, as Trump stated, and the Fed will need to increase interest rates more than a few percentage points to stave off the inflation that will come from such an influx of dollars.
The normalization of monetary policy is what will finally kickoff the long anticipated restructuring of the international monetary system. This first incremental rate increase is loaded with the financial energy of an atomic bomb.
And remember, shifting reserves into sovereign wealth funds to purchase equities could help balance and stabilize the stock markets. At least for a short while. – JC