The Floating Dollar Leaves Endless Victims In Its Wake

The Floating Dollar Leaves Endless Victims In Its Wake
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The International Monetary Fund was created as part of the Bretton Woods global monetary framework. Its primary task was to aid in keeping a stable global reserve currency regime. Once the gold exchange paradigm had fully collapsed in August 1971, the IMF was left somewhat twisting in the wind. It had in many ways lost its original mandate, even a clear reason for its existence. Floating currencies, many believed, made the institution obsolete.

The IMF had anticipated its precarious future position. In 1969, the Fund devised the Special Drawing Right (SDR) as a possible replacement for the looser gold system of Bretton Woods. There were, after all, so many obvious problems with the world’s monetary practice at that time – starting with the formation of the London Gold Pool in 1960 (technically a default under strict Bretton Woods terms) and then the curious (and largely forgotten) period of a two-tier pricing structure in gold later in that decade.

As the global monetary system was inexorably pulled further and further toward a bad end, the SDR’s would be ready to offer an alternate approach. They were originally defined as 0.888671 grams of fine gold, which just so happened to be the same as the US dollar (at $35 per oz). A total of 9.3 billion SDR’s were allocated according to IMF quotas.

They never really caught on, though, in some part because President Nixon acted before they were ready. On August 15, 1971, the President through the Treasury Secretary declared that the US dollar would no longer be convertible into gold at any price. While that seemed to have created an opportunity for the SDR in providing a stable reserve alternative, the truth is that the rest of the world had long before moved on to the next global reserve – the eurodollar.

Thus, SDR’s were left largely as a relatively minor accounting function. They were included in any nation’s official reserve calculations. This was because though an SDR wasn’t itself a currency, it was a claim on reserves of other currencies held by the IMF and therefore ostensibly its member nations.

There was a second round of SDR allocations in the late seventies, about 21.4 billion in total, as once again the IMF tried to fit itself into the dollar crisis then reaching its apex. Still, the world was as ever reluctant to move away from the eurodollar system, by then growing exponentially.

These things were largely forgotten for decades until in March 2009 PBOC Governor Zhou Xiaochuan wrote in an essay published by the BIS that it was his belief the global reserve system under the eurodollar (he correctly classified that system as “credit-based”) just wasn’t working any longer. Specifically, Zhou pointed to the SDR as one possible replacement that could absorb all the functions then being carried out by a devastatingly dysfunctional system.

Shockingly, only a few days after that piece was put out, US Treasury Secretary Tim Geithner, who somehow managed to be promoted to that office despite being the former head of FRBNY during its worst performance since 1929, was quoted in a private meeting at the Council on Foreign Relations as being “quite open” to the Chinese suggestion.

He backtracked, of course, almost immediately. Going public a very short while after the report unnerved some markets (remember, this was late March 2009), Geithner attempted damage control by saying, “the dollar remains the world’s dominant reserve currency.”  He also offered his view that it was likely to stay that way “for a long period of time.”

The day before, on March 24, 2009, President Obama at a press conference was asked about Zhou’s dollar (really “dollar”) criticism. Responding to a question from CBS News Correspondent Major Garrett, the President reiterated longstanding American policy – and the basis for what was wrong then, and remains wrong now.

Before telling Mr. Garrett, “I don’t believe there’s a need for a global currency,” Obama first said:

“As far as confidence in the U.S. economy or the dollar, I would just point out that the dollar is extraordinarily strong right now. And the reason the dollar is strong right now is because investors consider the United States the strongest economy in the world with the most stable political system in the world.”

That was, as usual, technically true but not in any way helpful about understanding what had just happened (and, indeed, at that moment in time, still happening). The dollar was “strong” only insofar as it wasn’t. In other words, the President, as everyone else, mistook the (rapidly) rising exchange value of the dollar for a positive when it was a clearly destructive force.

It was that which Governor Zhou was attempting to point out. The Chinese were not alone in their complaint. Almost immediately they were joined enthusiastically by the Russians, forming a pairing that for obvious reasons was politically distasteful and therefore unhelpfully provided a kneejerk if inappropriate defense of the monetary status quo.

Two days after the US President denied any “need for a global currency”, the Russian government began work on putting together a conference aimed at exploring just that. That country’s First Deputy Foreign Minister told Russia’s RIA news agency on March 26, 2009:

“This proposal is aimed at a practical realisation of the idea about a new global accounting unit or a new global currency. It is a question that should be discussed to create a consensus.”

At the G-20 summit held in late March/early April 2009, the Russians began backing the discussion in hard talks. At the conference, Russian President Dmitry Medvedev purportedly raised the SDR’s as a possible device to accomplish what his Foreign Department had already been describing. In an interview with the BBC, still in March, Medvedev said:

“You know, I have just discussed this issue with Gordon Brown and other partners. Of course, we are realistic, and I hope that my position is realistic, as well as that of our Chinese colleagues. But it is quite obvious that the existing currency system has not coped with the existing challenges. We were lucky to have a set of currencies: dollar, euro, and a pound. But in the future this system should be based upon a multi-currency basket, it should also include other regional reserve currencies.”

He proposed what he called “a kind of super currency.”  In April 2009, the IMF allocated another $250 billion in SDR’s to its members also in proportion with its quotas. Coming after the crisis was actually over (though, to be fair, it wasn’t clear at that time that it was), the IMF still to this day claims, “the 2009 SDR allocations totaling SDR 182.6 billion played a critical role in providing liquidity to the global economic system and supplementing member countries’ official reserves amid the global financial crisis.” I don’t believe they played any role let alone a critical one, but they did supplement the accounts of member countries’ reserves if after it was all over.

The IMF carried out a second allocation in September 2009 while at the same time at long last decreeing SDR’s as finally fully convertible.  The dollar was finished, right?

Almost as quickly as the idea spread at the worst economic and monetary moment since the Great Depression, it disappeared just as fast. That’s not to say all interest or even official agitation ceased or died out; the idea lingered on just not on the surface as it had in the flurry of those few months of 2009.

In very simple terms, what happened was QE. Changing the global reserve currency system is no small affair. Fraught with frighteningly negative consequences should there be any misstep (think UK 1925), this was no easy ask even for the Chinese and Russians who politically were vulnerable to legitimate Western suspicions on the matter. Faced with what many were thinking as a Great “Recession” that would not end, perhaps even a Great Depression 2.0, even the monumental was on the table at that time.

But the global economy began to recover and under “emergency” monetary policies put in place (after it was over) people and politicians were content to let them play out. Inertia is everything. Central bankers were largely considered (somehow) as the best and brightest, so for the public at large as well as officials everywhere, why not give them a chance? It really did seem on the surface as the path of least resistance, the option with the least questions and downside.

Now many years later, the appeal of the SDR has been curiously revived again, and not just in the occasional newspaper article.  Dollar dissatisfaction has returned with a vengeance, only this time there is less, in my view, effort to forge international consensus. They still call it that, those who propose to de-dollar the world, but it has taken more of a unilateral proposition (or increasingly bipolar – US vs. China and Russia).

Writing in the Guardian last April, Mohamed El-Erian wondered, “And with renewed interest in the stability of the international monetary system, some are asking – including within the IMF – whether revamping the SDR could be part of an effective effort to re-energise multilateralism.” Working for the IMF in the early eighties, El-Erian was a close observer to its downfall.

“In an ideal world, the SDR would have evolved into more of a reserve currency during the era of accelerated trade and financial globalisation. In the world as it is today, the international monetary system faces two options: fragmentation, with all the risks and opportunity costs that this implies, or an incremental approach to bolstering the global economy’s resilience and potential growth, based on bottom-up partnerships that facilitate systemic progress.”

I don’t agree with him on much if ever at all, but I think he is right in this narrow context. What’s happening, or what has already happened to some significant degree, is fragmentation. Both inside the eurodollar as well as various countries’ approach to it, the international standard that brought about the latter 20th century version of globalization is coming apart. It is entirely reminiscent of the sixties and the slow-motion end of Bretton Woods.

For one, QE didn’t achieve any meaningful goals. It just didn’t work; at all. So, while the dollar issue died down in the immediate “recovery” given the leeway hopes for central bank success provided in 2009-10, by 2011 there were renewed problems in the eurodollar system all over again. Worse, because officials here had never once come to terms with what really happened in 2008 (as I write, read the FOMC transcripts!), they approached the crisis in 2011 and more so its aftermath in the same ignorant state as before. 

Writing for Salon in April 2009, Christopher Beam spells out what Russian President Medvedev’s concerns and what he was aiming at, according to the standard, mainstream interpretation.

“Medvedev, the Chinese economic minister, and other would-be reformers want to create an accounting unit based on a ‘basket’ of other currencies—a sort of hybrid. Instead of countries holding billions of U.S. dollars in their reserves—which makes them vulnerable if the dollar drops suddenly—they would hold a new unit, composed of, say, the dollar, the pound, and the Euro.”

That’s not what happened, though. The Russians, Chinese, Brazilians, Canadians,

Saudis, etc., were never at risk of “the dollar drops.” The dollar had, as President Obama pointed out, remained as strong as ever – only too strong because it wasn’t strength propelling its exchange rate. Thus, if you look at the “strong dollar” as actually strong you are left outside wondering what all the fuss is about.

The dollar would rise again starting in spurts in 2013 and then almost all at once beginning in the middle of 2014. And like 2008, it was never strength that moved it ever upward. The consequences of this later “rising dollar” were devastating. For a great many places, including Russia and China, what happened 2014-16 in economic terms was for them equivalent to what happened here in 2008. This disproportion needs to be kept in mind.

I really don’t get any sense whatsoever that Western officials really appreciate the differences of outcomes. Governor Zhou was pushing for SDR’s in March 2009 as China’s economy fell off sharply during the worst of the Great “Recession”, but then it immediately rebounded just as sharply. By the end of 2016, by contrast, any and all ideas of growth were exhausted. To play for SDR’s in March 2009 was a hedge, a push toward future solution; in 2016, it’s a matter more of raw survival that won’t wait for Janet Yellen (or Jerome Powell).

And it was the “dollar” system that did it!  I wrote in these (web) pages in June 2015, just about two months before the devastating CNY disruption of that coming August, we here in America just weren’t seeing the full extent of what was already by that point a big problem.

“To a great extent, Americans are both sheltered and wholly unaware, but the rest of the world is very much alerted to the continued downside of the eurodollar standard. Stocks may be at or near record highs, but Brazil is in a state of total economic and financial chaos while China flirts with what was never thought possible. There was a "dollar" system somewhat in place, largely before the middle of 2013, which supported all those but no longer does.”

The missing monetary component was the same thing Governor Zhou pointed out in March 2009; credit-based currency.

“It seems quite clear that the global banking system is again finding itself short of capacity as dealers, what is left of them, scramble for the exits. What started in August 2007 was an irreparable separation between what was (dealer-based, multi-dimensions), what is (central bank-based, reduced dimensions) and what will be (nobody yet knows, which is precisely the problem). Unfortunately, rather than hang on for an orderly hand off between the second and third steps or transitions, banks are again, echoes of 2007, taking their part and leaving without much to fill in the wholesale gaps.”

The dollar “rose” not on strength but into global economic and financial destruction. These “strong dollar” periods have also featured the lamentable tendency to leave each and every target of its fury worse off. In other words, after each of these monetary events occurs, there is no recovery from it. The global economy gets worse each time and lingers on in a lower state for years - until the next one.

That’s exactly where we are now, everywhere from China to Brazil to Russia – to the United States. Even here the economy is closer to 2015-16 than it is to 2006, and nowhere near 1996. The great fears of 2009 have actually come to fruition, just not in they way anyone had ever predicted. 

The impetus behind the dollar criticism at that time was avoiding a worse fate than had already been experienced. It was largely assumed “worse fate” meant continued recession past the already serious collapse witnessed to that point (March 2009). No one ever conceived that “worse fate” might instead mean chronic weakness that exhibits perpetual and serious downside risks without much if any upside growth possibility (Japanification). Stretch that out over ten years and the result is something even a Great Crash 2.0 would have been preferable to.

SDR’s are not an answer. As they are currently constituted, no one seriously believes they are. Even the Chinese and Russians were not appealing to the form SDR’s take now to replace the dollar in 2009, rather they intended to use them as an opening to a discussion for how they might be reworked into something more serious and compatible with today’s monetary reality. It would have been a one-way discussion anyway, with Western officials still thinking about the dollar like its 1969.

What the appeal of SDR’s really represent instead is the level of frustration and danger being perceived as to staying with the current eurodollar system. Credit-based money. Reopening the topic as was done especially in late 2015 (with the somewhat symbolic admittance of RMB into the SDR) shows that there is precious little patience or benefit of the doubt left out among the rest of the world. Though not everyone is eager to follow China and Russia, indeed very few are, which is precisely their main problem, that doesn’t mean all are content with the no-growth status quo and nothing more than the presumption of recovery that so thinly covers it.

The dollar is in danger not from RMB and certainly not from rubles; it’s downside lies instead in continued fragmentation, a coming apart of the global monetary order forged in the sixties and making the nineties and 2000’s what they were (good and bad).

The eurodollar replaced the gold-backed dollar long before 1971. What will replace the eurodollar?  There is as yet no clear answer except that something will. Its demise is being worked on right now all over the world because American officials in their (nonpartisan) ignorance have left everyone no other choice. The role of SDR’s is simply to show us when it is getting serious; 1969, 2009, and 2017.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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