The Year of the Monkey

Economics, Premium POM

Interim Reform Solutions & the Beginning of a New Commodities Super Cycle

By JC Collins

Next year China will host the leadership of the G20. The timing is extremely fitting as the Chinese currency will become a part of the Special Drawing Right basket and the internationalization of the renminbi, along with its growing liquidity markets, will mark the beginning of a new era in international finance.

In China the Year of the Monkey represents cleverness and good fortune in business and wealth, and 2016 is set to offer exactly that.  The symbolism of this is not lost on the Chinese as their currency rises to the status of reserve and joins the US dollar, British pound, euro, and Japanese yen in the SDR.  The one area of contention has to do with the 2010 Quota and Governance Reforms of the IMF which were agreed upon by all members of the G20.

From the official G20 communique on November 15, 2015:

“We remain deeply disappointed with the continued delay in implementing the IMF quota and governance reforms agreed in 2010. The 2010 reforms remain our highest priority for the IMF and we urge the United States to ratify these reforms as soon as possible. Mindful of the aims of the 2010 reforms, we ask the IMF to complete its work on an interim solution that will meaningfully converge quota shares as soon as and to the extent possible to the levels agreed under the 14th General Review of Quotas. The 14th Review should be used as a basis for work on the 15th Review, including a new quota formula. We reaffirm our commitment to maintaining a strong, quota-based and adequately resourced IMF. We reaffirm our agreement that the heads and senior leadership of all international financial institutions should be appointed through an open, transparent and merit-based process and we reiterate the importance of enhancing staff diversity in these organizations. We reaffirm that the Special Drawing Rights (SDR) basket composition should continue to reflect the role of currencies in the global trading and financial system and look forward to the completion of the review of the method of valuation of the SDR.”

The first point of interest in the communique is that the 2010 reforms are considered in the same fashion as the inclusion of the RMB in the SDR composition.  The second is that the interim solution on reforms are connected to the consolidation of quota amounts.

But what does it mean to “converge quota shares”?

One possible explanation can be found in the book Reforming the IMF for the 21st Century.  There it states the following:

 “A possible interim solution to the quota and voting-share issue may lie in a combination of small ad hoc increases in a few countries’ quotas in addition to small voluntary reallocations of quotas without an overall increase in the size of the Fund, thus avoiding a need to increase total quotas.  A limited reduction in the US quota and voting share by less than one percentage point as a consequence of ad hoc quota increases in individual quotas plus an agreement by Canada, Japan, and the major European countries to reallocate portions of their existing quotas might free up a total of 4 percentage points of total quotas for reallocation.  That amount could be distributed to the six large non-European countries with quotas that, although they are now in the top 30 in terms of size, have the largest proportional discrepancies (greater than 30 percent) between calculated and actual quota shares.  The six countries are Singapore, Korea, Malaysia, Thailand, China, and Mexico, in decreasing order of their percentage discrepancies.  As a result, the average percentage discrepancy for this group would be reduced from the more than 100 percent to approximately 35 percent.  Such an approach, however, would leave five discrepancies of more than 30 percent between calculated and actual quota shares within the EU group – Denmark, Ireland, Luxembourg, Spain, and potentially Turkey.  Thus, the Europeans would come under internal pressure to negotiate some rebalancing within their nascent group even as they converge towards a single quota.”

It is clear that the converging of quota shares will take place within the EU countries in order to make room for a reallocation of shares towards the emerging markets as defined, with China being one of them.  This reallocation, or interim solution, will need to eventually give way to a “new quota formula” as expressed in the recent G20 communique.

The other interesting component of this strategy is the converging of quota shares within the Euro area.  Such a strategy could also play out within the Asian Monetary Unit zone, where it has been discussed here on POM could lead to an SDR2 type solution.  See post Meet the Asian Monetary Fund and Introducing the Alternative SDR2.

Such as solution would provide the workaround required for delays on quota amounts as well as the inclusion of the RMB into the SDR basket.  There is still a possibility that the Executive Board, by way of US veto, could prevent the inclusion of the renminbi into the SDR, but this would only strengthen the concept and functionality of the Asian Monetary Fund and SDR2.

The other troubling component of international finance is the level of sovereign debt which has exploded over the last decade.  We have reviewed both the Sovereign Debt Restructuring Mechanism of the IMF and the CAC, or Collective Action Clauses, both of which could offer viable solutions to the level of sovereign debt.

Also from the G20 communique:

“We welcome the progress achieved on the implementation of strengthened collective action and pari passu clauses in international sovereign bond contracts, which will contribute to the orderliness and predictability of sovereign debt restructuring processes. We ask the IMF, in consultation with other parties, to continue promoting the use of such clauses and to further explore market-based ways to speed up their incorporation in the outstanding stock of international sovereign debt. We look forward to the upcoming review of the IMF-WB Debt Sustainability Framework for Low-Income Countries. We acknowledge the existing initiatives aimed at improving sustainable financing practices, as stressed in the Addis Ababa Action Agenda. We also take note of the Paris Forum initiative, which contributes to further the inclusiveness by fostering dialogue between sovereign debtors and creditors.”

Interested readers can learn more from the following posts:

The Sovereign Debt Complex

And

Global Debt Consolidation Under New York Law

The Year of the Monkey for the Chinese will also see the full implementation of CIPS, or China International Payment System, which is not meant to replace SWIFT, but to allow for an expansion of renminbi liquidity.

Starting on January 1st the AEC trade agreement of the ASEAN+3 countries begins, which marks another milestone for the Year of the Monkey.

And let’s not forget that the Asian Infrastructure Investment Bank and BRICS Development Bank will be in full swing on the back of renminbi internationalization and growing liquidity.  This new market of accessible liquidity will provide the necessary funding for massive infrastructure development projects in the emerging countries.

All countries want to do what China has done over the last decade, and China will help provide the liquidity to make it happen, as it switches its economy from a trade exporting model to a trade services model which will provide RMB denominated financial instruments to the world market.

This massive infrastructure development will lead to a huge commodities boom and will kick-off the beginning of another commodities super cycle.  The sad reality is that commodities have been down for many years now, but the upswing will soon begin.

The Year of the Monkey will mark this moment in monetary history.  – JC