A Reversal in the Trend of International Reserves
Hugo Salinas Price
In the reasoning that follows, the statement "all other things being equal" must be understood.
What produces increases in the world total of International Reserves?
Increases in International Reserves take place when the Reserve Currency issuing countries (RC) effect payments to the rest of the world (ROW).
Typically, RC payments to ROW take place when:
a) The RC countries are purchasing more stuff from the ROW, than the ROW is purchasing from the RC. In other words, when the RC as whole run trade deficits with the ROW.
This is one of the main reasons for having a Central Bank world, in which some privileged countries issue fiat money classified as "Reserve Currency": the possibility of obtaining goods and services from the ROW, and "paying" with fiat money - dressed as a "Reserve Currency" - which costs nothing to create.
There is an undesirable consequence for the RC in doing this, because the advantage for the RC of running a permanent trade deficit with ROW brings with it the inevitable demolition of RC industry, as imports, necessarily cheaper, overwhelm local industrial activity.
b) RC payments to the ROW take place when the ROW government sectors borrow from the RC. ROW government sectors do this when their governments are running fiscal deficits, or when they have plans for "infrastructure development" which they cannot fund from the taxes they collect from their populations, or when they want to bolster reserves which may be falling due to falling exports to the RC. The RC may not be taking up the expected amounts of imports, because the RC economies may be falling into a slump; or alternatively, the ROW countries may have weakening exports because their governments impose too many burdens on their economies. And so the ROW borrows to cover up its falling exports.
c) RC payments to the ROW take place when the ROW private sector borrows from the RC. Generally speaking, the ROW private sector borrows from the RC when there is a desire to expand business operations and local ROW credit is unavailable or insufficient, or because ROW currency is not acceptable in the purchase of international capital goods, and also because RC credit is cheaper than local ROW credit.
There may be other reasons why payments flow from RC to ROW, but I think the above covers most of the operations.
Decreases in International Reserves happen when the ROW effects payments to the RC.
These payments have various causes:
a) When the economies of the RC slow down and business is slack, the purchases of the RC from the ROW diminish. Flows of fiat money from the RC to the ROW diminish, and the ROW does not receive expected flows of RC money, causing disruption in the ROW "Balance of Payments"; the ROW begins to lose reserves due to slumping export business, the ROW currencies devalue and raise interest rates in the attempt to stem the loss of reserves. Devaluation of the ROW currencies raises the relative value of the RC reserve currencies. Typically, the RC currencies become more expensive with regard to the ROW currencies, as the RC reduces imports.
b) The devaluation of the ROW currencies motivates the ROW private sectors to purchase RC currencies in order to reduce existing indebtedness in RC currencies: business is slowing down due to flagging exports to the RC, and reducing indebtedness in RC currencies becomes imperative.
c) The devaluation of the ROW currencies creates a capital "hot money" flight of RC currencies from the ROW to the RC; "hot money" investors seek to purchase RC currencies and get out of ROW currencies, as a protection against further devaluation. In an attempt to persuade "hot money" not to leave the country, ROW increases interest rates.
d) A further cause of a decrease in International Reserves might be found in purchases of gold on the part of the RC and ROW, paid with RC fiat money reserves. This would mean that some Central Banks may have decided to hold gold as a reserve, in precautionary addition to their RC fiat money reserves. Curiously enough, gold is not officially considered as a "Reserve Currency". Such Central Bank purchases of gold are perceived as disloyalty to the RC reserve currency system, and so such moves are kept secret.
So the question today is: "What's happening to international reserves in Central Banks?"
International Reserves peaked on August 1, 2014, at $12.032 Trillion dollars, and as of October 28, 2016 they stood at $11.066 Trillion dollars.
International Reserves stood at about $10 Trillion in 2011, but the rate of growth slacked off; the weekly increases in Reserves (which Bloomberg used to publish every Friday) stalled and became smaller, week by week. As mid-2014 came around, the increases were quite small. It was clear that the trend was for ever-smaller increases, and that could only mean that finally there would be no increase, which would be immediately followed by decreases in the total of International Reserves held by Central Banks. That is exactly what took place.
All "money" today represents debt: fiat money comes into existence as the counterpart to the creation of a credit. So the falling International Reserves are really the contraction of credit in the world. From the analysis of what causes increases in International Reserves, we see that it's all about the expansion of credit in the RC, which produces flows of fiat money RC Reserves to the ROW.
We see that China's exports are slumping; however, China is no longer a part of the ROW bloc: it is now part of the RC bloc, because its currency has been recently approved as a Reserve Currency by the IMF. So China is now in the same position as the US, Britain, the Euro zone and Japan: theoretically, it is now able to pay for imports not with RC money earned through exports, but with its new-born Reserve Currency, the Yuan. It remains to be seen, to what extent the ROW will be willing to accept Yuan in "payment".
Evidently, the creation of credit in the RC has not produced the demand for goods and services from the ROW that it had been producing up to August 1, 2014. A huge amount of RC credit was created in recent years, but the money went to the financial sectors and inflated the value of stocks and bonds. The money did not go to the millions of the populations of the RC, and so these populations and their businesses are not spending as they had been doing, on imported goods and services.
Thus, the ROW has fewer dollars to spend because sales to the RC are in a slump; consequently, ROW business wants to pay off previous RC credit because export business is bad, and the "hot money" is hot to get out of ROW investments, which are looking poorly. ROW currencies will therefore be devaluing constantly, from here on, and ROW interest rates will be rising. This is because the trend to increasing International Reserves that had been in place since the early 1970's (when dollars held abroad by Central Banks ceased to be redeemable in gold) is now over.
When a trend has been firmly in place in the world for 45 years, a reversal of that trend must be the result of a profound change which will produce a new trend that will not be easily altered, just as the previous trend was unalterable for 45 years. The new trend is deflation, contraction of credit.
International Reserves have been falling because they are made up of Bonds issued by RC, and these bonds are being sold off for cash; the purchasers may be either the banks of the RC or the RC Central Banks. In other words, Bonds held as Reserves are being liquidated by ROW Central Banks hungry for RC cash, so their price has to fall and the interest rate they produce has to rise. In tentative confirmation of this prediction, we have the incipient rises in the ultra-low interest rates on RC Sovereign Bonds which have been noted recently.
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After the failure of insane policies of ZIRP or NIRP, it is likely that we shall see another lunatic policy: extensive government spending in the RC, to "get the world economy moving again" and prevent deflation from taking hold.
Inflation is always and everywhere, the result of governments and their banking systems working together to increase spending; inflation can be a long drawn-out process, little noticeable by the population. Deflation on the other hand, is the result of actions on the part of the public, and deflation can take place at great speed, feeding on itself as fear of losses in investments propels the public to liquidate investments as quickly as possible. Think of "Black Friday", October 1929.
At the present time, RC governments and Central Bankers are probably terrified that the whole investment world may suddenly collapse, as the fear of deflation - the fear of massive liquidation of Bonds and Stocks - may take hold of the public at any moment.
Thus, we are likely to see a desperate attempt at world inflation of money through further expansion of credit in the RC, to finance government spending in order to "get the world economy on its feet again" and crush any possibility of world deflation, for the time being. Which would, of course, only postpone the final collapse of the world's economy to some point in the future.