Russia and China are not alone in pursuing cryptocurrencies on distributed ledgers. A new class of global cryptocurrencies on a permissioned distributed ledger controlled by the IMF and central banks is also in the works. Consider this excerpt from the June 2018 IMF report, “Monetary Policy in the Digital Age”:
IMF managing director Christine Lagarde noted in a speech at the Bank of England last year, “the best response by central banks is … being open to fresh ideas and new demands, as economies evolve.”6 … Government authorities should regulate the use of crypto assets to prevent regulatory arbitrage and any unfair competitive advantage crypto assets may derive from lighter regulation. That means … effectively taxing crypto transactions …. Central banks should continue to make their money attractive for use as a settlement vehicle. For example, they could make central bank money user-friendly in the digital world by issuing digital tokens of their own to supplement physical cash and bank reserves. Such central bank digital currency could be exchanged, peer to peer in a decentralized manner, much as crypto assets are.
The IMF report should be understood as a declaration of war on nongovernment cryptocurrencies and a manifesto calling for government-controlled cryptos. One result is likely to be an e-SDR administered by the IMF that would facilitate swaps and secondary-market trading among IMF members who hold SDRs. In the event of a massive new issue of SDRs to mitigate a global financial crisis, the e-SDR should expedite issuance and speed transfers to adversely affected parties in the way fire engines from one town will race to another if a fire is out of control.
While Russian, Chinese, and IMF-sponsored digital currencies are in the works, other more curious events are unfolding in the sphere of world money.
The SDR and Gold
Has a global monetary reset already happened?
I was alerted to this possibility by a research report sent to my attention from a correspondent named D. H. Bauer based in Switzerland. An explanation of Bauer’s research begins with the dollar price of gold: $1,260 per ounce at the date of the report. Following the dollar price of gold, we consider that on a given day gold is “up” or “down” by, say $10 per ounce. When we make this observation we effectively quote a cross rate between U.S. dollars (USD) and one ounce of gold (GOLD) or USD/GOLD.
Next, we observe the U.S. dollar value of the SDR. This cross rate, SDR/USD, is calculated and published daily by the IMF. As of this writing, SDR1 = USD1.406570. That rate changes daily like any floating exchange rate. Bauer took the known rates of USD/GOLD and SDR/USD and applied the transitive law to calculate SDR/GOLD, a price that is not actively followed on trading screens. He then graphed the time series of both prices with trend lines from December 31, 2014, to March 31, 2018. The graph includes a black vertical line corresponding to October 1, 2016. That is the date the Chinese yuan was officially included in the SDR basket of major currencies. The other currencies are sterling, yen, euro, and the dollar. The data and graph show that before China joined the SDR, the dollar price of gold and the SDR price of gold were volatile and highly correlated. After China joined the SDR, the dollar price of gold remained volatile, while the SDR price exhibited far less volatility.
Importantly, the trend line of SDR/GOLD is a nearly horizontal line. Gold denominated in SDRs has been trading in a narrow range of SDR850 to SDR950, an 11 percent band with fluctuations of 5.5 percent above and below the SDR900 central tendency. The price exhibits mean reversion. When gold rallies to SDR950, it quickly falls back toward SDR900. Likewise, when gold sinks to SDR850, it rallies back to SDR900. No prices appear outside the range after October 1, 2016. This price band narrowed in early 2017 and was contained in the SDR875 to SDR925 range, a 5.5 percent total band, 2.75 percent on either side of the target. This narrower band is indicative of a currency peg. A first approximation hints the SDR has been pegged to gold at a rate of SDR900 = 1 ounce of gold. This implies a new gold standard using not dollars, but the IMF’s world money. A global monetary reset may have occurred without a formal conference or declaration. SDR900 = 1 ounce of pure gold is the new monetary benchmark.
The advent of low volatility in SDR/GOLD (versus prior high volatility) occurred on October 1, 2016. The near straight-line trend of SDR/GOLD after the Chinese yuan joined the SDR is practically impossible without an intervening factor or manipulation. The probability of this occurring randomly is infinitesimal. The SDR/GOLD horizontal trend line after October 1, 2016, is an example of autoregression. This appears only if there’s a recursive function (a feedback loop) or manipulation. In the case of SDR/GOLD, one can rule out a recursive function since gold trades in a relatively free market determined by supply and demand. One can also rule out randomness as statistically highly improbable. That leaves manipulation as the only explanation for the flat trend line in SDR/GOLD.
If the SDR price of gold falls below SDR900 (indicating a strong SDR and a weak gold price), the manipulator buys gold, sells dollars, and buys the non-dollar currencies behind the SDR. If the SDR price of gold rises above SDR900 (indicating a weak SDR and a strong gold price), the manipulator sells gold, buys dollars, and sells the non-dollar currencies behind the SDR. By monitoring markets and intervening continually with open-market operations in gold and currencies, the manipulator can maintain the peg. There are only four parties in the world with the resources to conduct this manipulation in an impactful way: the U.S. Treasury, the ECB, the Chinese State Administration of Foreign Exchange (SAFE), and the IMF. These are the only entities with enough gold and hard currency reserves (or SDRs) to conduct the large-scale open-market operations needed to peg the price.
One can eliminate the U.S. Treasury and ECB as suspects. Both are relatively transparent about their total gold holdings, foreign exchange reserves, and the SDR component of their reserves. (For the ECB we look at the large members, including Germany and France, for this data.) If either the Treasury or ECB were conducting open-market operations of this kind, changes in holdings of gold and SDR component currencies would appear in official reports. No fluctuations of any magnitude appear. That leaves SAFE and the IMF. Both are nontransparent. China has about 2,000 tons of gold, probably more—they don’t disclose the excess. China has also acquired SDRs in the secondary market in addition to official allocations provided by the IMF to its members. The IMF owns 2,814.1 metric tonnes of gold and can print SDRs in unlimited quantities subject to executive board approval. The IMF makes loans and receives principal and interest in SDRs that are traded among IMF members through a secret trading desk. Gold is traded surreptitiously by major central banks through the Bank for International Settlements (which also traded Nazi gold in the Second World War). The BIS is furtive and controlled principally by the same nations who control the IMF. China can also conduct gold purchases and sales for yuan or dollars on the open market in Shanghai and London and separately buy or sell SDRs for dollars or yuan through the IMF. China can buy or sell the SDR basket currencies separately through bank foreign exchange trading desks.
The targeted value of SDR900 per ounce of gold is intriguing, with dark implications for the future of the U.S. dollar. Currently a total of SDR204.2 billion are issued and held by IMF members. The IMF owns 2,814.1 metric tons of gold, equal to 90,475,284.87 troy ounces. If the IMF wished to make SDRs the sole global reserve currency backed by gold at a 40 percent ratio, the same gold cover as the U.S. dollar from 1913 to 1945, then the implied SDR price of gold would be equal to the quantity 0.40(204,200,000,000/90,475,284.87), representing the amount of SDRs divided by the amount of IMF gold in troy ounces times 40 percent. This quantity equals SDR902.8 per ounce, almost exactly the pegged price of SDR900 per ounce.
There is no evidence the IMF is implementing an SDR/GOLD peg. The IMF’s gold holdings have remained constant since 2010 and permission to launch the gold-peg operation is unlikely to have been granted by the United States or Germany. To the contrary, there is strong evidence to support the view that China is behind the peg. This is ironic; when the SDR was c
reated in 1969 it was originally pegged to gold and defined as a weight in gold (SDR1 = 0.88867 grams of gold). That peg was soon abandoned even as the dollar peg (USD1 = 0.02857 ounces of gold) was also abandoned. Now the SDR/GOLD peg has returned, albeit at a much higher price for gold.
Since this SDR peg to gold is informal and unannounced it can be abandoned at will. The peg probably will be abandoned sooner than later because Chinese sponsors of the peg have ignored the lessons of 1925, when the United Kingdom returned sterling to the gold standard at a level that overvalued sterling. The result was a catastrophic deflation in the United Kingdom that presaged the Great Depression. Likewise, the Chinese peg of SDR900 per ounce of gold is too cheap to sustain, given the scarce supply of gold and the growing supply of SDRs. More to the point, the IMF will print trillions of SDRs in the next global financial crisis, which will prove highly inflationary unless the IMF conditions the distribution of SDRs on the receipt of gold. China would have to sell precious gold reserves to maintain an SDR900 price. This would reprise the U.S. depletion of its gold reserves by 11,000 tons from 1950 to 1970 to maintain the Bretton Woods gold peg to an overvalued dollar. Still, this is an historic development. Even if the peg is nonsustainable in the long run, it’s a clear short-run signal that China is betting on the SDR and gold, not the yuan or the dollar. An important pillar of a global monetary reset seems already in place.
A Gold Standard Without Gold
An international monetary conference, with or without IMF involvement, or an SDR/GOLD peg are not the only paths to a global monetary reset. Unilateral action by nations seeking stability can create network effects that result in the emergence of a global monetary regime not unlike the classic gold standard that prevailed from 1870 to 1914. Is it possible for a single national currency to adhere to a gold standard when the issuer of that currency has little or no gold? Curiously, the answer is yes, provided the currency is other than the U.S. dollar.
A nation that wishes to peg to gold need only denominate its currency by weight of gold and allow the currency cross rate to the dollar to float freely. A holder of that currency wanting to convert to gold at the pegged rate could sell the currency to the issuer’s central bank for dollars, at a cross rate calculated to produce an amount in dollars that would enable the purchase of gold at market rates equal to the weight specified by the peg. There are transaction costs and frictions in this two-step process compared to a simple conversion of the local currency into gold. Still, those frictions could be reduced by prearrangement with a physical gold exchange that offered volume discounts, straight-through processing, and speedy delivery to safe non-bank storage for the account of the currency seller. Intermediation between the local currency and gold need not be conducted in dollars; it could be done in any currency accepted in a liquid market for gold. The Shanghai Gold Exchange, or SGE, would offer this facility. By arrangement, the holder of the gold-backed currency could sell that currency for yuan to the issuer’s central bank at a cross rate calculated to produce an amount in yuan needed to buy gold at market rates equal to the weight of gold specified by the peg. SGE would welcome this arrangement because it promotes the internationalization of the yuan while generating more liquidity on the exchange itself. This arrangement would also give the local currency issuer’s central bank an attractive alternative to dollars (or euros) for its reserve positions, so long as a liquid market in yuan/gold exists.
I call this de facto gold standard for non-dollar issuers the Malaysia Plan in reference to Mahathir bin Mohamad, former and, at this writing, current prime minister of Malaysia. Mahathir was the original currency warrior, who vociferously confronted George Soros and international bankers at the IMF annual meeting in Hong Kong in September 1997. This high-profile confrontation occurred at the peak of the Asian financial crisis that began the prior June. Sequential run-on-the-bank-style currency collapses were occurring in Thailand, Indonesia, Malaysia, and South Korea, later followed by similar collapses in Russia and Brazil. At the time, Mahathir, a physician, not an economist, inquired of his closest advisers whether fundamental conditions had changed in the Malaysian economy. Mahathir closed Malaysia’s capital account to prevent its foreign exchange being depleted by panicked bankers in London and New York after being advised that economic conditions were unchanged. For this he was castigated as a “menace” by Soros and privately disparaged both by IMF officials and developed-economy finance ministers. Yet Mahathir successfully defended Malaysia’s fragile foreign exchange reserve position, and its capital account was eventually reopened. A decade after Mahathir defied the conventional wisdom of international monetary elites, the IMF reversed course and said that there were circumstances, such as those confronting Mahathir, when closing the capital account is an appropriate remedy for hot-money stampedes. Mahathir was years ahead of his time in 1997; his actions have been fully vindicated in the meantime.
Mahathir ended his first spell as prime minister in 2003, as the longest serving prime minister in Malaysian history. I celebrated Mahathir’s ninetieth birthday with him and a small group of close friends at a private dinner in Kuala Lumpur in July 2015. His interest then was to find the best way forward for Malaysia in a world where it could not dictate the international monetary system yet could be victimized by it. The birthday dinner was part of a three-day closed-door dialogue. I was invited to discuss topics including currency wars, the IMF, and systemic risk.
Using Malaysia as an illustrative case, the Malaysia Plan mechanics would work as follows:
At this writing, the U.S. dollar (USD)-Malaysian ringgit (MYR) cross exchange rate (USD/MYR) is 4.0200. The dollar price of gold is $1,268 per ounce. That yields a price of gold denominated in ringgit of MYR5,100 per ounce. Assume the Malaysian government announces a policy of pegging the ringgit to gold at a fixed price of MYR5,100 per ounce. At that point, Malaysia would be on a gold standard at a fixed exchange rate.
Now assume the dollar price of gold rises to $1,350 per ounce and a ringgit holder wishes to exchange ringgit for gold at the fixed rate of MYR5,100 per ounce. In this scenario, the central bank would have to exchange ringgit for dollars at the USD/MYR rate of 3.7800 (versus the original rate of 4.0200, when the peg was set). This new rate of 3.7800 provides sufficient dollars to purchase one ounce of gold at the higher dollar price of gold, thus preserving the fixed ringgit price of 5,100 per ounce. The central bank does not need gold to preserve the gold peg; it merely needs enough dollars to allow the exchanging party to buy one ounce of gold for every MYR5,100 exchanged.
The objections of conventional monetary elites to this new gold standard are easily stated. Any fixed exchange rate, whether to gold, dollars, or another numeraire, impedes a central bank’s ability to steal from citizens through inflation and devaluation. The inflation-theft paradigm is critical to elite efforts to transfer wealth to themselves and their state apparatus in pursuit of a globalist policy agenda. Elites also claim that a fixed exchange rate invites a drain on the hard currency reserves of a currency issuer when the fixed rate is viewed as out-of-line with market prices. A fixed exchange rate arguably eliminates one leg of the Mundell-Fleming triangle, which holds that it’s nonsustainable to have fixed exchange rates, independent monetary policy, and an open capital account at the same time. This reduces policy flexibility and forces the local currency issuer either to abandon independent monetary policy or close the capital account to support the peg. Finally, the peg to gold introduces volatility into the local currency’s cross rate to the dollar, which could hurt local exporters. In the above example, USD/MYR moved from 4.0200 to 3.7800 in support of the MYR5,100-per-ounce gold peg as the dollar price of gold moved from $1,268 to $1,350 per ounce. That move corresponds to a strengthening of the foreign exchange value of the ringgit.
These objections are easily refuted. Elites’ inability to steal from citizens through inflation and devaluation is the allure of the plan, not a fault. Far from inviting a drain on foreign exchange, the stability that results fr
om a peg to gold attracts foreign exchange, as global investors see an opportunity to invest in potentially high-growth economies like Malaysia while preserving wealth through the peg to gold. Investors who will not buy gold directly because it lacks yield or due to other institutional constraints can receive the benefits of gold indirectly by investing in an economy with a currency linked to gold. Consider it back-door devaluation insurance. The Mundell-Fleming objection is a red herring; that model does not apply to gold because there is no central bank of gold and no policy interest rate for gold for hot money to arbitrage. The local currency (in our example, MYR) still floats against the dollar, so an independent monetary policy versus the Fed and an open capital account are entirely feasible under Mundell-Fleming. Volatility in the cross rate between the gold-pegged currency and the dollar is likely to be more the result of erratic Fed policy than changes in the subjective value of either gold or the local currency in question. Finally, the gold peg points the way to an investment-driven rather than export-driven path to growth in emerging economies. A stable currency value measured against gold attracts direct foreign investment and facilitates an exit from the middle-income trap that Asian economies have been stuck in for decades (with the notable exceptions of Taiwan, Singapore, South Korea, and earlier, Japan). Low-value added exports are an economic dead end once an economy pulls itself from poverty to middle-income status. Further progress requires the production of high-value added goods and services that are the fruits of investment, not cheap currencies. In short, the elite critique ignores second-order benefits of a stable currency while elevating the alleged but illusory benefits of inflation and devaluation as substitutes for sustainable growth.
Aftermath Page 23