What the IMF is discussing for Special Drawing Rights...
LESS THAN a month ago a handful of the world's policy makers gathered in Washington at the International Monetary Fund (IMF), writes Craig Wilson in Addison Wiggin's Daily Reckoning.
No surprising headlines were run – but an obscure meeting and a discreet report launched exclusive signals for the next global economic crisis.
The panel, which included five of the most elite global bankers, was held during the IMF's spring meetings to discuss the special drawing rights (SDR) 50th anniversary. On the surface the panel was a snoozefest, but reading beyond the jargon offers critical takeaways.
The discussion revealed what global central banks are planning for a future crisis and how the IMF is orchestrating policy for financial bubbles, currency shocks and institutional failures.
Why the urgency from the financial elites?
In the April 2017 "Global Financial Stability Report", IMF researchers targeted the US corporate debt market and how extreme changes in its equity market has left the global economy at risk. While the report may have been missed by major financial news outlets, it was enough to give major concern to those paying attention.
The IMF research report noted:
"The [US] corporate sector has tended to favor debt financing, with $7.8 trillion in debt and other liabilities added since 2010..."
In another segment the IMF report said:
"Corporate credit fundamentals have started to weaken, creating conditions that have historically preceded a credit cycle downturn. Asset quality – measured, for example, by the share of deals with weaker covenants – has deteriorated."
"At the same time, a rising share of rating downgrades suggests rising credit risks in a number of industries, including energy and related firms in the context of oil price adjustments and also in capital goods and health care. Also consistent with this late stage in the credit cycle, corporate sector leverage has risen to elevated levels."
This report together with the panel discussion highlights a very concerning trend. Jim Rickards, a currency wars expert and macroeconomic specialist, has identified the special drawing rights (SDR) as a class of "world money" that is a tool used to bailout central banks during crisis.
World money was praised for its ability to be a catalyst for international loans during the IMF spring panel discussion.
The panel discussion was moderated by Maurice Obstfeld, an established academic who serves as a Director of Research at the IMF. Obstfeld is connected, knows the right people, and can see the macroeconomic implications of SDRs.
In his opening remarks Obstfeld identified, "There has been increasing debate over the role of the SDR since the global financial crisis. We in the Fund have been looking more intensively at the issue over whether an enhanced role for the SDR could improve the functioning of the international monetary system...
"The official SDR is something we are familiar with but is there a role for the SDR in the market or a market SDR? What is the SDR's role for the unit of account?"
Here's the five most important signals from the world money panel, what they could mean for the international monetary system and the future of the Dollar.
#1. China Spars for the SDR Market
Yi Gang, the Deputy Governor of the People's Bank of China disclosed to the IMF panel that "China has started reporting our foreign official reserves, balance of payment reports, and the international investment position reports...
"All of these reports, now, in China are published in US Dollars, SDR and Renminbi rates...I think that has the advantage of reducing the negative impact of negative liquidity on your assets."
What that means in real terms is that China views the opportunity of being a part of the exclusive world money club as an opportunity to diversify away from the US Dollar.
The Bank of China official took that message even further saying that he hopes that China could lead in world money operations by integrating it into the private sector.
"If more and more people, companies and the market use SDR as unit of accounts – that would generate more activity in the market with focus on the MSDR. [The hope would be] that they could create more products and market infrastructures that would be available for trade products to be denominated in SDR."
The People's Bank of China official referenced how this trend was already underway. Just last year Standard Chartered bank began to maintain accounts in SDR's. "In terms of the first and secondary markets they will develop fairly well."
Perhaps the most important segment that the Chinese official signaled was his reference that "the Official Reserve SDR (OSDR) that allocation from the IMF is very important. [This allows] Central Banks to make the SDR an official asset, and easier for them to convert that asset into the reserve currency they need."
What that means is that China will become an even greater player in the world money market.
Nomi Prins, an economist and historian, stated when analyzing China's economic positioning, "The expanding SDR basket is as much a political power play as it is about increasing the number of reserve currencies for central banks for financial purposes."
#2. Liquidity and Central Banks
Jose Antonio Ocampo, one of the foremost scholars on international economics and a board member of the Central Bank of Colombia noted, "The main objective of SDR reform is actually...for it to be a major reserve asset for the international monetary system...
"First of all, it is a truly global asset. It is backed by all of the members of the IMF and it doesn't have the problems that come with using a national currency as international currency. Second, it has a much better form of distribution of the creation of liquidity. Because it is shared by all members of the IMF...in that regard, it does serve as unconditional liquidity."
That means that IMF and institutional economists view the SDR as a potential way of financing not only national government loans, but markets.
The most fascinating point that Ocampo made about the SDR was about the position of conditional reserves and what it could mean for more SDR reform. Conditional reserves reference the ability of central banks to borrow and repay loans in a timely manner with conditionality.
"Countries that hold excess SDR's should deposit them in the IMF. The IMF then could use those SDR's to finance its lending. [This will reduce] the need to have quotas, borrowing arrangements and methods to finance IMF programs. Like any decent central bank in the world they could use their own creation of liquidity as a sort of financing of that central bank."
While the IMF has been a "central bank for central banks" this proposal would see the international monetary system shift entirely.
Jim Rickards takes his analysis a step further showing that the liquidity and lending offer the IMF the ability to act during a crisis, as it did during the most recent global financial crisis.
New York Times best-selling author Rickards reveals, "The 2009 issuance was a case of the IMF 'testing the plumbing' of the system to make sure it worked properly. With no issuance of SDRs for 28 years, from 1981-2009, the IMF wanted to rehearse the governance, computational and legal processes for issuing SDRs."
"The purpose was partly to alleviate liquidity concerns at the time, but also partly to make sure the system works in case a large new issuance was needed on short notice."
#3. Elites Signal Blueprint Plan
Mohamed El-Erian a former Deputy Director of the IMF and the Chief Economic Adviser at Allianz (affiliated with Pimco) was the premier panelist to discuss the future blueprint plan of world money.
El-Erian started out his discussion, "If the SDR is to play a really important role you cannot go through the official sector only today."
He outlined the current political landscape for world money saying, "The politics today do not favor delegating economic governance from national to multilateral levels. Yet the case for the SDR is very strong."
"It is not only about the Triffin Dilemma and [acting as] the official reserve, it's because if you ask anybody do you want to reduce the cost of self-insurance, they'll say yes. Do you want to facilitate diversification? They'll say yes. If you ask anybody, do you want to make liquidity less reciprocal, they'll say yes...
"The SDR helps address every one of these issues. So, it solves problems not just at the official level but it solves problems in the private sector."
To break that jargon down, Jim Rickards offers: "In other words, the latest plan is for the IMF to combine forces with mega-banks, and big investors like BlackRock and Pimco to implement the world money plan.
"El-Erian is 'signaling' other global elites about the SDR plan so they can prepare accordingly."
#4. The Death of the Dollar
Catherine Schenk, a professor of International Economic History at the University of Glasgow, is one of the top scholars of economic relations. While speaking she took up the case of what the special drawing rights meant for the US Dollar.
Dr.Schenk when asked whether the international market could proceed without a "lender of last resort" she pressed, "Why would you use a relatively illiquid element when you have the US Dollar...?
"The US Dollar has a lot of problems, some of it is unstable but the depth and liquidity of it in financial markets are unrivaled. The history of trying to create bond markets for other currencies or other instruments shows that it takes a long time."
She then elaborated later in the conversation the premise that, "What we are talking about with the market SDR is trying to turn it and add more facilities to turn it into money. That will take time. Having reluctant issuing, I am worried about how that market it going to be created."
As the Dollar continues to have its issues what central banks like the Federal Reserve select to do matters significantly.
As Christopher Whalen pens, "Whether you look at US stocks, residential housing markets or the Dollar, the picture that emerges is a market that has risen sharply, far more than the underlying rate of economic growth. This is due to a constraint in the supply of assets and a relative torrent of cash chasing the available opportunities."
Whalen then asks the bigger question and one that could specifically matter for the SDR when he notes, "What happens when this latest Dollar super cycle ends?"
How the competition for the top world reserve position unfolds between the SDR and US Dollar will be answered in time.
#5. World Money Becomes Central Bank Money
During the final Q&A for the panel on the SDR's, they were asked what the political climate looks like facing the issues of world money and the direction of political headwinds?
In response Jose Antonio Ocampo said, "In the issue of liquidity, we still have a basic problem during a crisis – which is, how do you provide liquidity during crisis?"
Ocampo, the Colombian central bank official disclosed, "My view is that it is a function for the SDR as central bank money, let's say."
The SDR specialist took it further, "The real question is whether any of the major actors...and whether the US, either from the previous administration or the current administration, was willing [to politically act]?"
He offered, "From the point of view of the US the use of SDR's as a market instrument should be more problematic than the reforms of the SDR to be used as central bank money."
Under such circumstances the demand and confidence for the US Dollar as a global reserve would be diminished.
Jim Rickards summarizes, "By the time the final loss of confidence arrives, much of the damage will already have been done. The analytic key is to look for those minor events pointing in the direction of lost confidence in the Dollar."
"With that information investors can take defensive measures before it's too late."
As was confirmed by both the IMF report and the elite panel on special drawing rights, the US Dollar is facing severe competition while undergoing a fiscal crisis.
Rickards leaves a stark warning, "The US is playing into the hands of these rivals by running trade deficits, budget deficits and a huge external debt."