KW: Jim Rickards is a very thoughtful but very American biased commentator and that one eyed view regularly annoys me I don’t even consider reading some stuff of hi but this view is coming much more into focus. It is directly from his latest communication to readers and we have before posted one or more of his articles about SDR’s. We have to open our eyes to what is happening
Dear Reader,
The coronavirus pandemic is a human tragedy. It’s also an economic tragedy, as the global economy is collapsing around us.
Second-quarter U.S. GDP may drop as much as 30%, which is a staggering figure. Many economists predict a third-quarter recovery, but there are still so many unknowns that it’s impossible to say.
It’s still too soon to say when America will reopen for business. And you can’t just flip a switch and return things to normal. That’s not how economies function.
Many industries may never recover and millions may be out of work for extended periods.
At the very least, we’re heading into a severe recession. And we could well be heading for a full-scale depression.
That’s not being alarmist.
The crisis will also accelerate the collapse of the dollar as the world’s leading reserve currency. So you need to prepare now. What do I mean?
The U.S. dollar is at the center of global trade.
The dollar represents about 60% of global reserve assets, 80% of global payments and almost 100% of global oil sales. About 40% of the world’s debt is issued in dollars.
The Bank for International Settlements (BIS) estimates that foreign banks hold over $13 trillion in dollar-denominated assets.
All this, despite the fact that the U.S. economy only accounts for about 15% of global GDP.
The reason the dollar is the world’s leading reserve currency is because there’s a very large liquid dollar-denominated bond market. Investors can go buy 30-day 10-year, 30-year Treasury notes, etc. The point is there’s a deep, liquid dollar-denominated bond market.
But the coronavirus crisis is creating a massive problem for foreign nations dependent on the dollar.
That’s because the world is facing a critical dollar shortage.
Many observers are surprised to hear about a dollar shortage. After all, didn’t the Fed print almost $4 trillion to bail out the system after 2008?
Yes, but while the Fed was printing $4 trillion, the world was creating $100 trillion in new debt.
This huge debt pyramid was fine as long as global growth was solid and dollars were flowing out of the U.S. and into emerging markets.
But that’s no longer the case, and that’s an understatement. Global growth was anemic before the crisis hit. Now it’s contracting rapidly.
If dollars are in short supply, China can’t control its currency and emerging markets can’t roll over their debts.
But again, you might say, isn’t the Fed engaged in its most massive liquidity injections ever and extending swap lines to foreign central banks to ensure they can access dollars?
Yes, but it’s not nearly enough to meet global funding needs.
Foreign nations are scrambling to acquire dollars right now. And that surging demand for dollars only drives up the value of the dollar, which puts additional strain on their ability to service debt.
When those debt holders want their money back, $4 trillion is not enough to finance $100 trillion, unless new debt replaces the old. That’s what causes a global liquidity crisis.
We’re facing a global liquidity crisis far worse than the one that occurred in 2008. In fact, the world is heading for a debt crisis not seen since the 1930s.
The trend away from the dollar was already underway before the latest crisis, led by China and Russia. Now that trend will greatly accelerate as the world seeks to eliminate, or greatly reduce, its dependence on the dollar.
That’s not just my opinion, by the way. Here’s what Eswar Prasad, former head of the IMF’s China team, says:
“The dollar’s surge will renew calls for a shift from a dollar-centric global financial system.”
It can happen much faster than you think. And the dollar’s days are more numbered now than ever.
But what will replace it? And why can you expect the dollar to lose up to 80% of its value in the years ahead? Read on.
World Money
Since Federal Reserve resources were barely able to prevent complete collapse in 2008, it should be expected that an even larger collapse will overwhelm the Fed’s balance sheet.
That’s exactly the situation we’re facing right now.
The specter of a global debt crisis suggests the urgency for new liquidity sources, bigger than those that central banks can provide. The logic leads quickly to one currency for the planet.
The task of re-liquefying the world will fall to the IMF because the IMF will have the only clean balance sheet left among official institutions. The IMF will rise to the occasion with a towering issuance of special drawing rights (SDRs), and this monetary operation will effectively end the dollar’s role as the leading reserve currency.
The Federal Reserve has a printing press, they can print dollars. The IMF also has a printing press and can print SDRs. It’s just world money that could be handed out.
The IMF could function like a central bank through more frequent issuance of SDRs and by encouraging the use of “private SDRs” by banks and borrowers.
What exactly is an SDR?
The SDR is a form of world money printed by the IMF. It was created in 1969 as the realization of an earlier idea for world money called the “bancor,” proposed by John Maynard Keynes at the Bretton Woods conference in 1944.
The bancor was never adopted, but the SDR has been going strong for 50 years. I am often asked, “If I had 100 SDRs how many dollars would that be worth? How many euros would that be worth?”
There’s a formula for determining that, and as of today there are five currencies in the formula: dollars, sterling, yen, euros and yuan. Those are the five currencies that comprise in the SDR calculation.
The important thing to realize that the SDR is a source of potentially unlimited global liquidity. That’s why SDRs were invented in 1969 (when the world was seeking alternatives to the dollar), and that’s why they will be used in the imminent future.
At the previous rate of progress, it may have taken decades for the SDR to pose a serious challenge to the dollar. But as I’ve said for years, that process could be rapidly accelerated in a financial crisis where the world needed liquidity and the central banks were unable to provide it because they still have not normalized their balance sheets from the last crisis.
“In that case,” I’ve argued previously, “the replacement of the dollar could happen almost overnight.”
Well, guess what?
We’re facing a global financial crisis worse even than 2008. That’s because each crisis is larger than the previous one. The reason has to do with the system scale. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.
This means a market panic far larger than the Panic of 2008.
SDRs have been used before. They were issued in several tranches during the monetary turmoil between 1971 and 1981 before they were put back on the shelf. In 2009 (also in a time of financial crisis). A new issue of SDRs was distributed to IMF members to provide liquidity after the panic of 2008.
The 2009 issuance was a case of the IMF “testing the plumbing” of the system to make sure it worked properly. With no issuance of SDRs for 28 years, from 1981–2009, the IMF wanted to rehearse the governance, computational and legal processes for issuing SDRs.
Regards
Jim Rickards
for The Daily Reckoning