A Glimpse Into The New Monetary Architecture

This is an excerpt from the latest Advisory Board meeting by Incrementum Liechtenstein as summarized in 25 Monetary And Economic Insights From Incrementum’s Advisory Board. The full transcript is below. In this article, we highlight the thoughts of Jim Rickards (first part of the article) and Heinz Blasnik (towards the end) when it comes to the future of our monetary system.

Global Depression

Going back to the 4th quarter and even the middle of last year, there was a high expectation of a rate increase in 2015 and the talk back then focused on the debate between the March-people and the June-people. March has now come and gone. There will not be a rate increase in June. The debate has shifted to the September-people and a small number of December-people. I have said often that the Fed will not be able to raise rates in 2015.

Right now the Fed’s Funds Future Market is pricing the rate increase for December, it would not take much to push it out to 2016.

Here is the problem: The Fed desperately wants to raise rates, there is no question about this. They signal it, they warn the markets, they continue to talk about it. Anybody who is still in a leveraged Dollar-carry is warned to get out of this trade.

The problem is that actually raising rates and warning people that you are probably going to raise rates is not the same. Meaning: you still have this issue of data dependence. Now where the Fed gets it wrong is that they have removed all forward guidance. The Taylor rule is gone, the shadow gold standard of Greenspan is gone, basically every rule that was used in the last 30 years has been abandoned. The Fed only has two options: one is their own forecast; the other is data dependence.

Here’s the problem with those two tools: The Fed has the worst record when it comes to forecasts. All the way through the last 6 years, they have been wrong each year with their growth forecasts by a huge magnitude. So they are relying on forecasts that are always wrong. But they still trust those numbers.

Now the problem with data dependence is that this data is mostly lagging. You are always the last to know. So you have two tools that do not work and they are flying blind.

You have two states of the world:

Either, the Fed blinks, throws in the towel, says there is no chance of a rate increase in the foreseeable future and says QE4 is not off the table. Then you’ll see a huge rally.

Or, the Fed actually raises rates in September – which is not my assumption – and this turns out to be a disaster as they would be hiking into weakness. Then stock markets get crushed, and the dollar rallies.

What they are doing is the old Draghi trick… talk tough and do nothing. The Fed keeps promising to raise rates, but they don’t do anything.

Now we have this somewhat schizophrenic market, where on certain days, weak data comes out and the market believes that this will delay the rate hike. Then on other days, Fed officials come out and talk tough. So this is another example of what we saw in 2011/2012 in Europe, which is non-directional volatility.

I do not think that business cycle analysis matters in this environment. From my point of view, we have been in a global depression since 2007. People say: “You’re crazy Jim, we are having an expansion for 6 years now, growth is up, unemployment is coming down, etc.” The defining characteristic of a depression is that growth is significantly below potential. So if potential is 3 or 3.5% in the long run and 5% in the short run and your actual growth is 2%, that is a depression from my point of view.

So if you take annual numbers, the US economy has been growing at 2% for 6 years. That is a depression, as the potential is much higher. No monetary authority can do anything to get us out of this mess. We need structural changes, not monetary stimulus.

My expectation is 2% growth as far as I can see, no rate increase but some volatility because of talking tough on the one hand and doing nothing on the other.

A New Monetary Architecture

What to think of the newly created Asian Infrastructure Investment Bank, a multilateral institution which is challenging the Bretton-Woods institutions (the IMF and the World Bank), is an important development to closely follow. There are 43 nations that have signed on so far – including Germany, Switzerland, the UK, France, but also South Korea and even Taiwan, who all are allies of the US. Is this a kind of further sign that the emerging market countries are ready to challenge the status of the US and the US Dollar? Jim Rickards answers these questions.

I view it a little differently than a lot of analysts. This whole notion of the BRICs and China buying gold, and China and the other BRICs coming out with a kind of gold-backed currency and trying to question the status of the Dollar as reserve currency – I do not think any of that is actually what is going on.

What is going on? China really does not care about the BRICs. China cares about China, China does what suits China, and of course the BRICs was an invention of a salesman of Goldman Sachs, so it does not have any intellectual content.

China really wants for the Yuan to be included in the SDR basket and to get more voting rights at the IMF. So China is really a friend of the IMF and a friend of the Bretton Woods institutions. But the United States Congress and to some extent the United States Treasury are standing in the way of China’s ambitions trying to get sort of good behavior or a quit pro quo from China in terms of the Yuan-Dollar cross rate.

So China has set up alternatives to the Bretton-Woods institutions and they will make real loans, will get real capital. Why are they doing it? It is really a strategy to get what they want from the US and the IMF. They say: “We want to join your club, but if you don’t let us join your club, we’ll set up our own club and we can get a lot of members in our club and the importance of your club will diminish.” And what it really means is that China wants to be part of the old boys club, which is the IMF.

Now, a couple of interesting questions. I think we will see the Yuan included in the SDR later this year. It will be discussed at the Spring Meeting on April 17th, probably voted on by the executive board at the annual meeting in early October and become effective January 1st 2016. So I think that is the timeline for including the Yuan in the SDR. The bigger question is, will the US congress approve China’s quota increase. That remains to be seen, as we are in the political season in the US now.

China Looking To Join the IMF

Heinz Blasnik adds an additional comment to the above thoughts.

I would like to add that what the Chinese government really wants is to join the old boys’ club: the IMF and that the Asian Development Bank is a sort of side track thing, somewhat saying “Well you didn’t give us what we wanted, so we are now setting up a competing institution”. In the end, they would probably like to merge it with the World Bank or something like that. It is really a move towards the centralization of everything.

Furthermore, I wanted to make a comment on the depression framework and on the pool of free funding. First of all, I would characterize a depression period as one in which the cyclical economic expansions are very weak in a historical context, while the downturns are very strong. So, when the next downturn comes, it is very likely going to be a very painful one. And with regard to the pool of free funding, this is something that we cannot measure; but we can infer from central bank policy that has been implemented that it has to hurt the pool of free funding. And there are a few indicators that we can watch in this context: these are the production indexes that show how much is being spent on consumer goods production and how much is being spent on capital goods production. And since the 2008 crisis, something has happened that had never happened before, namely that the production index of capital goods in the US has actually risen above the consumer goods production indexes. We can infer from that that too many consumer goods are probably tied up in production and not enough to be released – so this is an unsustainable state of affairs. So, I would say the economies in the world are all on very shaky ground. That central bank experiment that has been going on since 2008 is a very, very big mistake. And I fully agree also with Jim that in the end, this is going to lead to the implementation of another monetary architecture – only I fear it is going to be another type of fiat money system, probably an even more centralized one than is in place now.

Transcript of the Advisory Board

Transcript of Incrementum’s Advisory Board April 2015

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