Monday, December 12, 2016

Global trend in - Evolution of International Monetary System

Most traders and businesses walk knee deep in sea of information moving markets, feeling daily movements of exchange rate waves and periodic business cycles like high and low tides. But to feel the stream of ocean to know the direction one must swim further and deeper far outside of well travelled monetary sea roads where movements are tracked in years or decades. Let me bring you few Thoughts.
Since the year 1971 and the day when Richard Nixon "broke the gold window" we live in a USD dollar dominated International Monetary system (IMS). Some say this is a non-system. Never the less the arrangement is very asymmetrical with only one debtor of international monetary reserves, the United States of America. So far it has proven to be rather very resilient but since seventies there are continuous discussions on a changeover and systemic improvements. Reserves of other states and monetary liquidity still depends on U.S. deficits - Itself a multilateral issue. Other possibilities like SDR have proven to be just a dead end, the complementary reserve asset is not to become major part of asset portfolios. The wider Triffin dilema is well present and still valid. It is to be seen if a shared responsibility in Multi polar multi reserve IMS would bring pareto-efficient solution of countries willing to share the burden. I do share thoughts, allegory of Tommaso Padoa-Schioppa on inventing a flying object, that inventing a fully aeroplane is another issue.
The system is evolving, it has never stopped nor started. The ascent of first truly modern currency the € brought gradually the end of the chronic dollar inflation exports. These famous words of Nixon-era US Treasury secretary John Connally "The dollar is our currency but your problem" are now in reverse. The move to Bipolarity (€-$) is slowly enforcing US fiscal discipline. The Exorbitant privilege becomes Exorbitant burden. The biggest bull market in government bonds is at its end, while interest rates have fallen in defence of the system. Lifting them too fast now could bring the whole system down. International cooperation has created safeguards, institutions like IMF changed its modus-operandi, new were created, like for example the Financial Stability Board (FSB), or regional Asian AIIB.
Many economists missed the 2002 Willem Frederik „Wim“ Duisenberg Aachen acceptance speech and do not understand its implications:
“The euro, probably more than any other currency, represents the mutual confidence at the heart of our community. It is the first currency that has not only severed its link to gold, but also its link to the nation-state. It is not backed by the durability of the metal or by the authority of the state. Indeed, what Sir Thomas More said of gold five hundred years ago – that it was made for men and that it had its value by them – applies very well to the euro.”
The Euro is simply irreversible. There are issues with fiscal rather than in monetary plane. Another issue many confuse. The Euro area may be seen not as Mundel´s optimal currency area but BoP surpluses are no more recycled into US Treasuries and US debt instruments but into deficit of close economic partners who need to implement structural reforms until then Target2 imbalances will still be with us.
The system is evolving. The end of 2014 experienced the change in the mode for oil exporters when financial intermediaries are loosing pricing power and "high volume" becomes again the predominant mode rather than the maximization of profit based on high price. The market cap of oil market experiences a drop from 2,5T $ to about 1,2T $. The global FX activity peaked at the same time. The whole energy complex went down, commodities bubble naturally came down as well as energy is often a major part of commodity direct expenses. Not surprisingly central bank forex reserves peaked in the same time as well. Central banks became providers of liquidity expanding their balance sheet and monetary base. Oil producers return to pre 1971 "floating dollar" of no shortages era where long term strategy with about 10% readily available reserves in case of disruptions are readily available instead of just-in-time deliveries as in volatile post Nixon world and they have now changed their dollar pegs due to new currency regime to floating.
€ and $ together represent over 40% of the world economy and China´s Renmimbi about 14+%. Multi polarity grows. Currency area-wise, the Euro area is growing while the USD currency area camp is shrinking on the background of China creating slowly its own currency area. The Euro area has both accounts positive, capital and balance of payment (BoP), invests outside and it simply exports more stuff than it imports and given the fall in energy prices, it implies improvement of Europe´s competitiveness as it is a net importer of energy. The opposite of what happened to Italy during the Oil shocks (artificial 400% increase of oil price).
Rules of the game are changing on the background of new economic system emerging. It is the surplus economies who direct the shape of monetary system. But in interdependent global system the win-win option is cooperation of debtors and surplus economies to bring inefficiency of surpluses and deficits with too high cost of holding reserves. Addressing the issue from int. reserves focus point of view the solution would be one world currency which is politically not reachable. Other more workable solution is fully functional floating rate world not requiring additional reserves but pure such system is just hypothetical. The world may even experience next gold fever would main reserve holders find workable solution for inherent undervaluation and two tier market, so this old asset may still be considered to bring IMS improvement. There are trends to be followed. One such is that all surplus economies EU, China, Oil exporters are located on EuroAsia continent while the system is underwritten by biggest debtor the US which lost its primacy as a major economical power.
In other words monetary affairs is after 50 years of dormant hibernation slowly becoming very interesting topic.
Now we watch together!                      

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