By JC Collins
Global markets are showing increasing signs of instability and there are serious concerns about risks to international liquidity building across the spectrum. Exchange rate volatility is deepening with the Russian ruble leading the way and the systemic contagion is spreading around the world, from European and Western banks to stock market crashes in the Middle East.
Oil continues its descent into the $30 to $40 dollar range with a strategically timed announcement by OPEC today, at the peak of the turmoil, stating it will not meet again until June, 2015, ensuring continued instability and lack of confidence in the energy markets.
Trading between the ruble and USD has been halted almost at the same time as Russia’s alternative to the SWIFT system came on line.
Since the beginning of the year we have rehearsed these moments in our minds, not sure if they would happen as we had been discussing, and hoping that they wouldn’t, but knowing full well that the amount of preparation and strategy which has gone into the transition of the international monetary system, from a unipolar structure to a multilateral structure, would eventually materialize in the real world as the Hegelian Dialectic machinations which we are witnessing now.
A look through the headlines on such sites as Zero Hedge will quickly give the reader a birds eye view of the destruction that is now taking place in the international financial system. Much of it is exactly what we have been expecting as a part of the problem, reaction, solution dynamic which will engineer and implement the multilateral financial system.
It was always expected that the transition would require some level of crash or instability. Like massive deflationary periods before, wealth is being transferred to the top as if it was being sucked through a straw. The script which states the USD system is too blame for the instability has been widely distributed beforehand along with the inability of the central banks to increase liquidity in the event of another financial crisis.
Whether any analysts or colorful commenters disagree, the system is shifting towards the multilateral framework that has been developed over the last 5 years, and the implementation is now unfolding as expected. The USD framework is being abandoned as the necessary component of the “reaction stage”, in order for the “solution stage” to manifest as the logical evolution of the financial framework.
The BRICS economies, being Brazil, Russia, India, China, and South Africa, have expanded the structure of the international financial system by implementing the New Development Bank and Contingency Reserve Arrangement. Most analysts and commenters promote the story that the BRICS countries are going to overthrow the Western banks and implement their own gold backed system.
This simply is not true or factual as the BRICS countries themselves are demanding reform to the International Monetary Fund, as agreed in 2010 by all 188 members, including the American administration. And China has been quickly internationalizing the RMB for inclusion into the SDR basket composition by next July, a date which quickly follows the next OPEC meeting in June, 2015.
The blueprint and engineering surrounding the SDR based multilateral financial system can be found in a document titled Enhancing International Monetary Stability, published by the IMF in January, 2011. Interested readers should be highly encouraged and motivated to read and fully understand the document.
In short, the USD system is creating systemic instability and a new multilateral reserve asset is required to balance the international system of finance and create stable liquidity. Some of the methods and components of this transition and new system can be found in the idea of substitution accounts.
The purpose of the substitution accounts is mainly for the exchange of IMF members foreign reserve assets, such as USD, for SDR denominated claims and assets. SDR assets will, at least for a few years, enhance global liquidity and facilitate hedging.
One of the expected risks associated with using SDR denominated assets is the exchange rate disparity, and who will carry this risk. This can be countered by using the SDR as the unit of account within a fixed exchange rate system.
Other methods of reducing the risks associated with SDR denominated liquidity can be found in reporting international transaction data in SDR, and presumably denominating all foreign trade in SDR, which would publish balance of payment statistics in SDR as well.
In line with transitioning away from the USD based system, SDR pegging would encourage a true multilateral global monetary policy and framework which would stand in contrast to the imbalances found in the current system, which is based on the policies of a single country, or economy, being the USD.
In the document titled Enhancing International Monetary Stability, in regards to implementing an SDR based system, the following Costs and Mitigating Costs are quoted:
Costs: SDR-denominated assets would operate in a shallow market at first and therefore would likely carry a liquidity premium. This is estimated initially at around 80–100 basis points, which could render it too costly for any individual country or IFI to take the first step and provide the impetus for an SDR-bond market, particularly in a context of fiscal consolidation pressures.
Mitigating Costs: To enhance initial market liquidity and reduce the premium faced by first movers, it may be useful to have a ‘group’ issuance where a number of countries issue jointly, thus expanding the volume issued, reducing fixed cost to individual issuers and the liquidity premium. Coordination should be aimed at establishing relatively quickly liquid benchmark instruments throughout the maturity spectrum.
These statements are clear indicators of the move away from the USD based system, as the countries that leave the dollar system would need to coordinate and create joint issuance of SDR bonds and liquidity. The BRICS group of countries provide this coordination and the New Development Bank and Contingency Reserve Arrangement provide the means to jointly issue SDR liquidity as a coordinated transition away from the USD system.
The theory that the BRICS economies are moving away from the USD is factual, but only towards the multilateral framework of the SDR, as developed by the central banks themselves and the global institutions. Though countries such as Russia and China may use gold to support their currencies in the interim, it is more likely that gold will become part of the SDR basket composition next July, along with the Chinese renminbi, and possibly the Canadian and Australian dollars.
It is heartrending that so many are losing and will continue to lose as the transition continues. Everything from pension funds, real estate, and possibly even continued devaluations in gold and silver, at least in the short terms, will be bombarded by the liquidity squeeze taking place.
Only last month I was talking with a real estate agent here in Canada and told him that home values are going to come down by approx 20% to 30% because of the deflationary period we have been entering and a decrease in global liquidity, with a bigger drop in oil. The agent almost laughed and stated that BMO and other Canadian banks have been publishing material that stated prices will continue to increase.
Since that weekend oil has decreased another $25 and the Bank of Canada stated last weekend that homes prices in Canada are over valued by 10% to 30%. Considering the turmoil that is taking place around the world, I wonder what that agent is thinking now, especially since the Alberta oil market is taking a big hit and companies are cutting their CapEx budgets for 2015, as well as putting in place hiring freezes, with potential lay offs coming in the New Year.
We are only at the beginning of this transition and expect to see even deeper instability wash upon North American shores in the coming days and weeks. The obvious “event” will be China stepping away from the USD. But how that will coordinate with the substitution accounts and issuance of SDR bonds through the BRICS group is not discernible at this time. It can be expected that SDR bonds will not be issued until the basket composition is changed and the 2010 IMF Reforms, being Plan B, are fully implemented. Plan A, which would have lead to a more constructive transition required the US Congress to pass legislation supporting the 2010 Reforms, which it hasn’t. Let’s hope that the Plan B process doesn’t take until next July. Perhaps an emergency session is in order for the New Year. – JC