The Made in America Comeback, TPP, AEC, and SDR Composition
By JC Collins
The value of the dollar has been based on international demand and investor preferences for USD denominated assets. The reserve status of the dollar has maintained this demand and preference. Without the reserve status the dollar would have weakened based on the large trade deficit which the United States has developed. Equally, the trade deficit would not have developed if the demand for dollars was not created with the reserve status.
America’s trade deficit is as much a problem for the rest of the world as it is for America. The only way foreign investors in dollars and dollar denominated assets can get paid on their investments is for the trade deficit to eventually turn into a trade surplus.
One method of making this happen entails allowing the dollar to depreciate, which would make imported goods more expensive for Americans, but would also make exports cheaper, which would boost domestic production and increase GDP.
The balance between a decrease in imports and an increase in exports, the outcomes of a depreciated dollar, will gradually allow the US to move from a trade deficit to a trade surplus. Foreign investors, both private and public, will be paid and America will strengthen both its domestic and international economic standing.
The timing of the dollar depreciation is directly tied to the availability of an alternative reserve asset. The Chinese renminbi and its increasing internationalization is creating the availability of an additional reserve asset which can be used by China and its trading partners to slowly shift away from dollar denominated assets.
But it isn’t enough to create the level of change and access to reserve alternatives that would be required to correct the balance of payments deficits which have put incredible pressure on the international monetary system.
There is also the concern that increasing the status of the renminbi to a reserve currency will sway the inherent deficiencies of the Triffin Paradox from the USD to the RMB. The accumulation of USD in the foreign exchange reserve funds around the world is the active cause of America’s trade deficit and balance of payments problems.
The incremental and gradual exchange of this USD accumulation needs to be reversed and brought into balance so the dollar can be allowed to depreciate. The unwinding of this dollar based framework is challenging and will take considerable more time than many realize.
Trade agreements such as the Trans-Pacific Partnership and the AEC, or ASEAN Economic Community, are being developed as frameworks for the new multilateral monetary realities that will be unfolding in the coming months and years.
The AEC is a trade agreement between ASEAN nations and will include the participation of China and Japan. It will be effective on Jan 1, 2016, which could correspond with the implementation of the TPP, which is America’s trade agreement with ASEAN.
The Jan 1, 2016 timeframe is important as it will also be the effective date of the new SDR basket composition, which will include the Chinese renminbi.
The IMF will grant the RMB reserve status and set it’s weighting in the currency basket called the Special Drawing Right. There will be a reduction in the USD’s weighting in the SDR to accommodate the inclusion of the RMB.
What the actual weightings will be for each currency in the basket is difficult to determine as only a small contingent of monetary framework developers are building the multilateral architecture. But we can learn much from the implementation schedule of the trade agreements and changes to reserve currencies which will be taking place.
Though everything is connected and intertwined throughout the financial system, it needs to be understood that the draining of liquidity from equity markets around the world, like is presently happening in China, and soon elsewhere, perhaps by October, are actions that need to happen to make the multilateral transition more effective.
The unfortunate part is that many lose savings and stock market corrections always lead to institutional failures and a tightening of credit. The fact that global deflation is taking place at the same time does not encourage a sense of confidence in the existing monetary framework.
Which is the point.
Solutions will begin to be offered and presented as a means of correcting the imbalances and staving off the collapse of bond markets and sovereign debts. This script will unfold from the debt crisis with Greece, and in the larger Euro Zone as a whole.
It is internationally accepted that the reserve status of the USD, and the large accumulation of the US currency in the foreign exchange reserve accounts, have been the direct causes of the imbalances and deficiencies which have caused the current and escalating problems in the international monetary framework.
The inevitable correction to this situation will include the trade agreements mentioned above, in coordination with a depreciation of the dollar. As stated, the depreciation of the dollar will spur a new era of “Made in America” products, which will create jobs and expand domestic growth. This will lower the debt-to-GDP ratio of the US and make the sovereign debt more manageable.
Many like to see that a collapse of the dollar is unavoidable. It is important to differentiate between a gradual depreciation of the dollar and a collapse of the dollar. They are two separate concepts with completely differing outcomes. America is setting itself up to come out of this transition in a strong economic position.
Though TPP details are scarce and secret, and no doubt there will be some negative parts of the agreement, it will help develop the trade framework which will ensure a market for American made goods. The Chinese investment into US infrastructure and derelict factories begins to make more sense when considered in this fashion.
Based on the information presented here, and using some basic deduction techniques, it is probable that we could see the beginnings of the USD depreciation in the last part of this year, or early in the first quarter of 2016.
All the pieces are moving in unison.
The broader composition of the SDR, which will include the RMB, will decrease demand for dollars and create an alternative reserve asset to both the USD and RMB, eliminating future balance of payments challenges like the ones which have surrounded the USD. – JC