23 May 2011

Which Currency Will Be The Next Global Reserve?

Many commentators are baffled that Ben Bernanke decided NOT to announce QE 3 a month ago.
The reason for this is obvious: the Fed only got about three months’ worth of positive economic movement from QE 2 and it blew gas and commodities through the roof doing it.
Remember, QE 2 was only just announced in November 2010. And anyone watching the US economic data knows that we took a sharp turn for the worse in Feb 2011.
So all told, we spent some $600 billion and only got about three months’ worth of improved economic data (not to mention that this “improved” data was massaged heavily).
So it’s pretty obvious why the Fed hasn’t announced QE 3 yet… it needs things to get terrible in the financial markets again so everyone will be clamoring for it to intervene.
Remember last year? QE ended in March. Then we get the worst May performance in over 40 years with stocks dropping like a brick… which then allowed the Fed to announced QE lite and QE 2.
Just like today.
The Fed is going to let QE 2 end in June. We will very likely see some kind of collapse in stocks start even before then. My personal expectation is the S&P 500 will drop to 1,100 or so at which time it will announced QE 3 with a “SEE? We NEED Qe in order to keep things afloat.”
And that’s when the US Dollar will REALLY collapse and inflation hedges will explode across the board.
The Fed is already setting this up. Their latest FOMC minutes make it clear that they are downplaying the negative news today so that when things get REALLY bad in a few months, they can act surprised and push for a MASSIVE QE program.
So in the near-term deflation is now the biggest risk. It may only be for a month or so, but it’s coming (commodities’ and the US Dollar’s performance over the last two weeks were the warm-up. And then comes the REAL fireworks.

This is a continuation of a series of essays I wrote concerning the global shift away from the US Dollar as reserve currency. If you missed those essays, a brief recap of the items listed were:
1)   China and Russia dropping the US Dollar for trade
2)   China ramping up trade with Brazil
3)   Saudi Arabia moving to strengthen trade with China and Russia
4)   China, Russia, Brazil, India, and now South Africa are moving to trade more in their own currencies (not the US Dollar)
5)   Singapore (major financial center in Asia) starting to trade yuan
All of these items are real and documented. And the pace of the move away from the Dollar as reserve currency is not slowing.
Indeed, it was just revealed that ASEAN+3 countries (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam, China, Japan, and South Korea) are researching the prospect of a “common currency” similar to the Euro.
The significance of this development cannot be overstated. The primary question those who do not believe the US Dollar could lose its reserve currency status ask is: what will be the replacement?
For certain there is no one currency that could fit the bill. The Chinese yuan could not do it as China is not ready and in fact ready to suffer a housing and banking collapse. Russia’s economy is a disaster aside from a few key areas (Moscow, St Petersburg, etc), the Euro in its current form won’t even exist in a few years, and Japan is both an ecological and financial disaster (they’ve just announced a 1 QUADRILLION stimulus plan.
Thus, the idea that any one of these currencies could replace the US Dollar as reserve currency of the world at this time is absurd.
However, a common currency comprised of most Asian countries (the primary creditor nations and manufacturing base of the world) is a completely different story.
Understand, I am aware that common currencies in general are flawed (especially when you’re uniting a bunch of bankrupt aging countries like Europe). However, a common currency comprised of Asian countries would overcome be a much more viable alternative to the US Dollar as reserve currency of the world.
The reason for this is that a common currency in Asia would get past the individual risks of any one Asian nation’s currency (Thailand and Japan in particular are a mess) at least in the beginning.
True, ultimately a common currency there would prove as futile as the Euro. However, it would serve as a “stepping stone” in the process of finding a replacement of the US Dollar as world reserve currency.
What I mean is that should a common currency be introduced in Asia, it would probably work for about 10-15 years. By then we’re well into the 2020s if not the 2030s at which point it is quite possible China will indeed be in a place to provide a world reserve currency on its own.
I wish to stress that even if Asia doesn’t implement a common currency and the US Dollar remains the world’s reserve currency (I put the odds of this at 20%), we are still facing a debt default in the US which will result in the US Dollar dropping dramatically in value and ushering in serious if not hyper-inflation.
Indeed, most commentators fail to understand the real reason Weimar Germany suffered hyperinflation. Niall Ferguson’s book, “The Ascent of Money” explains that it was in fact a political mistake that ushered in hyperinflation:
Yet it would be wrong to see the hyperinflation of 1923 as a simple consequence of the Versailles Treaty. That was how the Germans liked to see it, of course…All of this was to overlook the domestic political roots of the monetary crisis. The Weimar tax system was feeble, not least because the new regime lacked legitimacy among higher income groups who declined to pay the taxes imposed on them.
At the same time, public money was spent recklessly, particularly on generous wage settlements for public sector unions. The combination of insufficient taxation and excessive spending created enormous deficits in 1919 and 1920 (in excess of 10 per cent of net national product), before the victors had even presented their reparations bill…Moreover, those in charge of Weimar economic policy in the early 1920s felt they had little incentive to stabilize German fiscal and monetary policy, even when an opportunity presented itself in the middle of 1920.
A common calculation among Germany’s financial elites was that runaway currency depreciation would force the Allied powers into revision the reparations settlement, since the effect would be to cheapen German exports.
What the Germans overlooked was that the inflation induced boom of 1920-22, at a time when the US and UK economies were in the depths of a post-war recession, caused an even bigger surge in imports, thus negating the economic pressure they had hoped to exert. At the heart of the German hyperinflation was a miscalculation.
The similarities between the US today and Weimar pre-hyperinflation are striking. As in Weimar, US fiscal authorities are not taking any steps to rein in their loose money policies. Similarly, the US Fed, like Germany’s financial elites believes that currency depreciation is a good thing.
Thus we have a rather frightening set-up for hyperinflation in the US: the largest emerging market players are moving away from using the US Dollar at the same time that US monetary authorities are engaging in disastrous policies similar to those employed by the men who brought hyperinflation to Weimar Germany.
I firmly believe the US will see serious (‘70s style inflation) if not hyperinflation within the next 2-3 years. It could come sooner depending on how the Fed’s policies play out.
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