US Dollar Depreciation & the Return of American Exporting
By JC Collins
This article was originally posted on July 6, 2015. The Trump Mandate part of the title was added to reflect the stated positions of the Presidential Candidate and how certain aspects of those policies are aligned with the process of unwinding Bretton Woods. Such early policy indicators as having EU countries take on more of the funding responsibilities of NATO, others countries participating more than the US in their own defense, and reworking existing trade agreements, are all aspects of unwinding Bretton Woods, which was centered around using the USD as the international reserve asset. – JC
The Bretton Woods monetary framework has been segmented into opposing eras. One era began in 1944 when the USD was established as the international monetary unit used to balance trade. This period lasted until 1971 when the Nixon Shock removed the gold standard component of the original Bretton Woods and set the stage for Bretton Woods 2, which began in 1973.
Unmoored from the valuation and reserve levels of gold, the dollar could be printed relentlessly and began to accumulate in the foreign reserve accounts around the world. This massive imbalance, as represented by the amount of dollars in reserve accounts, and subsequent balance of payments deficits, were the largest contributors to the financial crisis early in the 21st Century. For all intents and purposes Bretton Woods 2 ended in 2008, at the beginning deflationary event referred to as the Great Recession.
In 1944 the United States had a record trade surplus. After 71 years of expanding the USD money supply to facilitate the demand for dollars in the international monetary framework, the US now has a record trade deficit.
This crisis is perpetuated by the fact that the USD is used as the international money clearing unit, a role which was originally designated for a multilateral global currency called the bancor during the Bretton Woods conference, but was vetoed by the United States to the benefit/detriment of the dollar.
Since 2008 the world has been establishing trade agreements and engineering the architecture of the replacement to the unipolar USD based monetary framework with a multilateral framework which will adjust the deficiencies in the balance of payments between nations.
The process of unwinding Bretton Woods is complicated, challenging, and fraught with macroeconomic volatility and geopolitical tension. But the international monetary system is ready for the change.
The QE policies of developed nations are meant to manage the deflation which is systemic within the existing framework. This is nowhere more obvious than in the shortage of financial market liquidity which is exposing worldwide markets to such increased risks as:
- US Treasury flash crash
- Reduced prices in FX markets
- Plunge in EUR/CHF
- And fears in the corporate bond markets
Market finance is defined as market money funds, repurchase programs, and commercial paper, and are now at the lowest levels since the late 1990’s. In fact, market finance is now 30% below the required levels needed to support liquid financial markets and global economic growth.
When we compare this with the record trade deficit of the United States, and the large volume of USD’s which have accumulated in foreign reserve accounts globally, it is complimentary that we find US Treasuries to be overvalued and at the highest levels since the 1920’s.
In this monetary framework both stocks and bonds are overvalued, with bonds being more overvalued. The unwinding required to correct the imbalances and make the needed adjustments must come soon.
For instance, the longer the Federal Reserve waits to raise interest rates, the more costly the exit from the existing monetary policy and the unwinding of Bretton Woods becomes.
The path forward for the international monetary system will consist of economic growth through new multilateral liquidity, as well as the unwinding (adjustments) to correct the existing and epidemic distortions and imbalances.
Markets will correct.
Between now and the end of 2016, the volatility associated with this unwinding can be tracked and measured by watching the indicators associated with the following metrics:
- Balance of Payments
- Capital Flows
- Treasury Bills
- Bond Auctions
There are two important factors which need to be considered and implemented for a stable unwinding. They are:
- The evolution of economic growth through multilateral liquidity.
- Transformation of the international monetary framework from unipolar to multilateral.
Both factors only work when applied together and in unison.
In the post When Will China End the Dollar Peg, we covered the strategy which China has implemented to increase domestic consumption and switch from a trade exporting model to a trade services model. This is important because when China boosts domestic consumption there will be reduction in deflationary pressure along with a decrease in their trade surplus.
This means less USD accumulation and a reduction in the trade deficit of the United States. This adjustment will also be complimented by a depreciation of the dollar (since it is overvalued), which will in turn increase American exports, further correcting the balance of payments deficits.
Balance of payments corrections can also be facilitated by using the fiscal and current account surpluses, along with the exchange reserves, to fund infrastructure projects, public services, and further boost consumption. This will facilitate the unwinding of global imbalances.
Expect commodities to begin the valuation climb as global consumption is boosted on the back of multilateral liquidity.
Countries like China, Saudi Arabia, and Iran, with large trade surpluses, will increase their domestic demand, which will also boost the exports of deficit countries, like the United States. This is why the TPP and AEC trade agreements are important to the multilateral transition and unwinding of Bretton Woods.
The unwinding of imbalances could be disorderly, which would cause sudden movements in exchange rates, such as what was witnessed with the EUR/CHF. This risk and threat can be averted by using a reformed International Monetary Fund, along with other multilateral institutions, like the BRICS Development Bank and the Asian Infrastructure Investment Bank, to make the adjustments to the balance of payments.
The merger of all multilateral institutions into a new International Clearing Union (which was intended back in 1944 to support the bancor) could be a very real possibility in the coming years.
The world is on the threshold of monetary change as the unwinding of Bretton Woods proceeds. The imbalances which have accumulated and formed over the last 7 decades will not be adjusted without some heartache. But this can be minimized if all countries come together within a true multilateral framework. This was what was intended back in 1944. – JC
Help support POM and further research by subscribing. Members will receive more detailed analysis on macroeconomic trends and have access to the Fundamentals of Multilateral Investing Lessons.
Monthly subscription cost of $15.00 or receive a 33% discount with a one year subscription cost of $120.00.