Monday, April 25, 2016

New Article Proposing Using SDR to "Finance Global Reflation" Supports Jim Rickards Prediction?

Readers here know that we have followed the SDR story for quite some time here and covered it in depth. We started following this story because a few years ago Jim Rickards issued a prediction that another major financial crisis in the future will lead to the IMF issuing trillions of new SDR's in order to "reflate" the system after the crisis. In our research here, we have found evidence that this a plausible theory (although likely a gradual process absent a crisis) and have documented it here in articles with direct input from a leading expert in the world on SDR's, Dr. Warren Coats

Now we have a new article by Andrew Sheng (U. of Hong Kong) and Xiao Geng (U. of Hong Kong) that appears to be supportive of the idea that the SDR could be used in the future to reflate the global system. Below are quotes from this new article appearing on Project Syndicate and following that are some added comments including some by the former head of the SDR Division at the IMF (Dr. Warren Coats).


How to Finance Global Reflation

"There is a growing awareness that, in today’s globalized world, financial markets are beyond the control of national policymakers. While a few economies do have the scale to shape interconnected global markets, they face serious constraints, political and economic. As a result, the global economy is stuck in a pro-cyclical financial cycle, with few options for escape.

As Claudio Borio (BIS) pointed out years ago, the global financial cycle is longer and larger than real economic cycles, and is closely associated with the fluctuating value of the dominant reserve currency, the US dollar. When the dollar is weak, capital flows from the United States to other countries, where it spurs growth through increased credit."

. . . . . . 

"With the US, the issuer of the world’s preeminent reserve currency, unwilling or unable to provide the liquidity needed to close the infrastructure investment gap, a new supplementary reserve currency should be instituted – one whose issuer does not have to confront the Triffin dilemma. This leaves one option: the International Monetary Fund’s Special Drawing Right (SDR).

Of course, the road to becoming a reserve currency is long, especially for the SDR, which currently functions only as a reserve asset, with an issuance size ($285 billion) that is small relative to global official reserves of $10.5 trillion (excluding gold). But an incremental expansion of the SDR’s role in the new global financial architecture, aimed at making the monetary-policy transmission mechanism more effective, can be achieved without major disagreement. This is because, conceptually, an increase in SDRs is equivalent to an increase in the global central bank balance sheet (quantitative easing)."

. . . . . 

"Consider a scenario in which member central banks increase their SDR allocation in the IMF by, say, $1 trillion. A five-times leverage would enable the IMF to increase either lending to member countries or investments in infrastructure via multilateral development banks by at least $5 trillion. Moreover, multilateral development banks could leverage their equity by borrowing in capital markets. Depending on the quality of the projects, in terms of governance and cash flows, they could subsequently be sold back to investors as asset-backed securities to fund new projects."

My added comments: This article clearly calls for a major expansion of the SDR and offers a proposal as to how this could be done by existing central banks. This proposal would not require another major crisis to move forward as it suggests the reserves created under this proposal could be used to finance global infrastructure projects. Jim Rickards immediately called attention to this article on his Twitter feed here. It should be noted that the authors of the article acknowledge that absent a major crisis "the road to becoming a reserve currency is long, especially for the SDR." This is also in line with what we have reported here. Willem Middelkoop writes a new blog post about this article here.

I reached out to Dr. Warren Coats (former head of the SDR Division at IMF) to get his reaction to the proposal in this article. Here is what he had to say about it:

Thanks Larry.

While the authors (of the "How to Finance Global Reflation" article) mischaracterize the operation somewhat, it is totally feasible under current rules.  They propose a large allocation of SDRs that countries would use to lend to the development banks for a large increase in infrastructure lending. This would not involve any increase in IMF lending contrary to what they state. While the SDR allocation would also relieve country reserve demand and the larger stock of SDRs would improve the resilience of the international monetary system, it would do nothing to improve the character of SDRs and how they are issued as I have proposed

Moreover, the spending stimulus they propose comes totally from increased project funding by the development banks. This financing could come directly from member countries rather than by allocating and then investing SDRs in the development banks. The proposed approach probably avoids the need for national budget approval for increased funding of the development banks. The bottom line question is whether the development bank chosen and directed infrastructure lending by the development banks is the best way to go. I am skeptical.


note: Dr. Coats gave permission to quote his email comments.

additional added note: It is interesting that this whole idea of using SDR's in the future as a global reserve currency was virtually unheard of (at least in general media) when Jim Rickards first talked about it. Having followed this now for some time, it is noteworthy that you now see this mentioned more often in serious media articles (like this one linked above). I give Jim full credit for bringing this whole topic to my attention as I would not have known about it at all had I not heard him talk about it years ago. Also, my curiosity to learn more about this led me to Dr. Coats and others who I view as leading experts in the world. I feel this has benefited readers here who want to learn more about this topic.

This may seem like an off the radar subject now, but if the SDR is eventually seriously proposed as a global reserve currency to replace the US dollar, it will be very important for people to have the best information available. I think some of that can be found here thanks to Jim Rickards, Dr. Coats and others who have helped point the way to more accurate information.

added note from Willem Middelkoop: Willem posts this link on his twitter feed which goes to a 2012 Chatham House gold study group report on the idea of using gold to "anchor" the SDR at some point. The report looks at the idea, but says it believes it is unlikely to happen for reasons listed on pages 18-19.

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