Money Base Growth, the Vietnamese dong, and No More QE

By JC Collins

Each week the monetary world is moving closer to a fundamental change. The lack of money base growth, or money based creation, being overall liquidity in the system, is beginning to deepen the global deflationary period which began in 2008, and hasn’t experienced a sustainable shift towards growth since.

This lack of money based creation is most profound in the developed G20 nations and will continue as long as the central banks of the other emerging nations maintain a currency peg to the US dollar. The fact that nations such as China, Vietnam, Kazakhstan, Angola, and Azerbaijan, among others, have devalued their domestic currencies against the USD in recent months and years, is a testament to the direction which the monetary world is shifting.

There are multiple methods of expanding the international money base. The main central banks could once again begin a quantitative easing program. Some central banks have in fact started these programs, but no real effect can be made until the Federal Reserve restarts a QE program, since most nations are connected to the USD through an exchange rate regime.

The obvious draw backs to QE programs is a loss of confidence in the dollar and further erosion of the ability to create domestic jobs in America. Something which will be high on the agenda this election cycle.

Another method of increasing money base growth would be for the monetary authorities in the US to willingly devalue the USD by 20% to 30% against the currencies of its major trading partners, and those nations maintaining dollar pegs. This is a sticky issue because though that is the desired outcome, the political will is likely lacking for such a drastic move, and the majority of the American population would understand the larger benefit of increased exports and job creation. It would be considered further weakening of America’s hegemonic position in the world.

The option with the greatest potential at this point in time is for the central banks of other nations, specifically the emerging nations, such as China, Vietnam, and others, to not just devalue their currencies against the dollar, but to actually end and de-peg their currencies from the USD.

China, and the others listed above, have begun this process by devaluing the existing peg, but this is only producing marginal results, as the dollar itself has been strengthening over the last few years.

The USD does not provide an optimum currency area for the rest of the world. As such, its use as the primary reserve currency and exchange rate mechanism is problematic and needs to end. The US monetary authorities, at this time, appear to be unwilling to devalue the dollar to the benefit of itself and the rest of the world.

The world is move around this road block, with some support from within the US system, and further devaluations and outright de-pegging from the USD will continue and pick up pace during the remainder of this year. The September 4th G20 meetings in China could mark the beginning of this time period. The effective date of the new SDR, which includes the Chinese renminbi, will be October 1, 2016. This will mark the next period of transition and will likely spark a renewed effort by emerging nations to devalue against the dollar and end pegs altogether.

East Asia, and Asia as a whole, provides an excellent optimum currency area, which could use the growing role of the renminbi as a new pegging mechanism which will provide fundamental money base creation.

Vietnam expressed a few years ago that they would need to end the dollar peg and peg the dong to the currency of their largest trading partner, China, or to a basket of currencies, which could be the SDR or a regional currency unit used by the ASEAN+3, which has yet to be announced. All would be supported by the expanding role of the renminbi as a reserve currency.

The dollar de-facto and unsustainable optimum currency area, abstract as it is, will be further eroded in the coming months. This by no means suggests that the dollar is dying or will crash. A modest depreciation of the dollar, such as the 20% to 30% suggested above, would be a positive for the American economy. Whether this depreciation is forced on the US or it is enacted willingly as official policy, means little at this point. The transition is happening and any additional devaluations by the emerging nations against the USD will only force the hand and eventually lead to the upward valuation of those currency as the monetary world rebalances from decades of dollar abuse and overuse.

Quantitative easing and other counterproductive monetary policies will not be enacted by the Federal Reserve. It would produce the opposite result of what the American monetary authorities are planning.

Sustainable money base creation can no longer be provided but the USD alone. That more than anything else, is the conclusive evidence that a shift is upon us. – JC