Thursday, March 19, 2015

So When Do We See Significant Monetary System Change?

This blog was started in January 2014 with the intention of tracking significant changes that we felt were coming to the international monetary system. At that time, there was a lot of speculation that major change was imminent. Respected analysts from both mainstream and alternative media sources were expecting a sharp drop in the US dollar at any time. This dollar crisis was expected to lead to some major changes in the monetary system. Now we are midway through March 2015. There has been no dollar crisis and no real significant changes to the monetary system that the average person would notice. Does this mean major change is not coming? Let's look at it.


First let's review what has actually happened because as we say here all the time, the only thing that matters is what actually happens. This is what impacts our daily lives, not whatever our favorite guru believes is going to happen. That is an important point we will try to stay true to here. Let's use a Q&A format to look at what actually happened and then see if our main premise for the future (that major monetary system change is coming) has been negated.

Q: Why didn't the enormous QE program carried out by the US Fed crater the US dollar like so many were expecting?

A: The answer is probably fairly simple. Even though the Fed did massively increase its own balance sheet by buying up US bonds using newly created money, the velocity of money never really picked up enough for money to get into the real economy. Money flowed into US stocks and bonds possibly creating new asset bubbles there (still undetermined). The Fed managed to prevent the major banks from going under, but did not achieve its goal of getting 2% inflation into the real economy (lowering the value of the dollar). Meanwhile, a lot of newly created money did find its way overseas as emerging nations took on a lot of debt in US dollar investments. As other parts of the world have struggled with disinflation or deflation, they have implemented easy money policies. This caused the US dollar to look better than everything else for now. Since it was already the world reserve currency, the dollar staged a big rally. For now, the US dollar has moved up sharply instead of cratering. This is what has actually happened.

Q: How long will the US dollar continue to rally?

A: This is much more difficult question to answer. If the US Fed really does start into a prolonged program to raise interest rates, we can expect the dollar to continue to be strong. Money will just keep flowing into US dollar investments as other currencies lose value. On the other hand, the strong US dollar rally is now starting to concern the Fed and other central banks around the world. When you see anything move up in a parabolic manner (just look at a US dollar index chart), you know it is reaching an unsustainable pace. It can continue for longer than people expect, but at some point it will peak out and the correction/pullback off of that will probably be pretty dramatic. A guess might be that if the Fed does not raise interest rates, the dollar could start to fade pretty quickly. If they do raise rates, it might peak out later this year or early next year. No one has a crystal ball to know for sure.

Q: What other factors are there that would cause major monetary system changes?

A: Here we need to continue to watch the IMF. Any major changes to the international monetary system are most likely going to come through the IMF until proven otherwise. It's true that the BRICS nations are increasing their influence on the world stage and that they are starting up financial institutions (BRICS Bank, Reserve fund, etc) that could potentially compete with the IMF in the future. But those institutions are not even going to be operational on a serious basis until next year. The action this year is all at the IMF. Later this year the IMF will do its next review to determine if the basket of currencies for its SDR will be changed to include the Chines Yuan (and perhaps some other currencies as well). If the Yuan comes into the SDR basket, that will qualify as a significant monetary system change even if it may not immediately impact most people in ways they would recognize in their daily lives. We will follow it here to see what actually does happen.

Q: What about IMF reforms? What happened to those?

A: A funny thing happened on the way to the 2010 IMF reform package getting approved. The US Congress refused to go along. Despite a massive campaign to pressure the Congress to accept these reforms (and vastly increase the total quota of SDR's at the IMF), they just said no. Since the US essentially has veto power at the IMF (17% vote where 85% total vote is needed to pass the reforms), the reforms are stalled. This has frustrated the IMF and the BRICS greatly, but they have not given up on getting the reforms implemented one way or another. They will try again later this year to come up with a way that might involve bypassing the US Congress. This situation has mostly certainly delayed the IMF from moving forward towards some of the major monetary system changes we expected to happen. But for now, they are just delayed, not ended. We will continue to cover it here to see what actually happens.

Q: Will there be a sudden crisis event that causes major changes?

A: This possibility is always on the table. No matter how calm things may seem, under the surface in the global financial system there are always risks sitting there that can surface at any time. We live in a globally interconnected world now filled with highly leveraged derivatives investments. All the major banks still have them. There is a "shadow banking system" out there as well where the risks are virtually completely unknown (even to the IMF and the BIS). We have covered all these risks here pretty fully (use the archive links to the right on the blog to research them if you like). No one can possibly know all the risks or when they might explode in a way that is not containable in the present system. It could happen next week or might not happen for years. I don't think there is anyone who can predict the timing of an event like this at all. So, what we have to do is understand it is a real risk we have to account for in our own personal planning, but not be surprised if it does not happen as soon as some might be forecasting. We even need to realize it might not happen at all if the risks are well managed in the system.

Q: How will change happen if there is no sudden major crisis to prompt change?

A: This is actually an easy question to answer. Change will just continue to happen more slowly and surely over time in a more controlled manner. I have no doubt that major monetary system changes are coming. If they don't happen suddenly, they will still happen. I feel very sure that 10 years from now we will look back and see that a lot of major monetary system change has taken place. However, if we are fortunate to avoid another major crisis, the changes will be phased in over time.They will be less likely to immediately impact the average person on a daily basis. Think of it this way, look how change has taken place in the technology world in just the last 10 years. For example, no one had an i-phone then.

Q: If change comes more slowly, what can we expect to see?

A: Again, no one has a crystal ball. But I can offer some ideas on how things might change based on what I feel are solid sources and some individual research. Unless the BRICS nations really do abandon the IMF (something I don't expect but will follow), I believe we will continue to see the world move towards the use of the SDR more like a global reserve currency (more like the US dollar has been used). I think the SDR basket will be expanded to reflect the more current realities of the global economy (China will get a bigger seat at the global table). As this is happening at the global level, I believe that new digital currency technology will continue to be tested and roll out on a regional basis around the world. We will see regions form monetary unions that move towards a common currency. I think we may eventually see an effort to tie the SDR (used only internally at the IMF right now) to an outside digital currency that can be used and owned by anyone along with their own national currency. 

Q: What role will gold have in the monetary system in the future?

A: I believe gold will continue to have an important role no matter if it is used to officially back any future currency or not. The facts that I see are that all the major nations own substantial gold reserves (or at least the public believes they own them which is what matters). There appears to be a "re-balancing" of those gold reserves in progress so that China and other nations that have held less gold reserves will own more. If we get another sudden major global crisis, this would set the stage for a global monetary "reset" conference like Jim Rickards has suggested. Gold would probably underpin the new system one way or another, whether it was used to officially back currency or not. If conditions were such that the financial institutions like the IMF and Central Banks had lost the trust and confidence of the public, they would probably officially bring gold back into the system in some way to help restore public confidence. They would not have to use a fully convertible gold standard to do this. Partial backing along with other assets might work just as well or better. It all boils down to confidence. No monetary system will work unless the vast majority of people believe in it and will use it. So long as the existing financial  institutions (IMF and Central Banks) maintain public confidence, we can expect they will carry out their agenda over time in a controlled manner. If they lose public trust and confidence, all bets are off and we move into a completely new world of unknowns. We will follow it here to see what actually happens.

Q: How can one prepare for such uncertainty?

A: I think keeping it simple is a good idea. First, stay informed (we try to help with that here). Next, understand the real risks out there and have as flexible a plan as possible to deal with the risks. Once you have a plan, don't waste time worrying about what might happen. Worrying is pointless. Instead, focus on staying informed and enjoying life.

Final comments: 

As things are unfolding, the article I wrote on January 1st 2015 "Monetary System Change for Dummies" still looks valid to me. In that I listed four possible future scenarios and a few simple common sense ways the average person can plan for whatever scenario actually does unfold. Nothing I see happening now causes me to think things have changed. As time passes, it will become clearer which scenario is unfolding. I think all four are still possible for now.  I think that article will work fine for quite awhile into the future, so I will continue to re-post it on the first day of each month here for new readers to find more easily.

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