Looking at the central bank reserves throughout the globe via Bloomberg, an interesting trend emerges. International reserves have declined from 12.032 trillion in August of 2014 to 10.814 trillion in January of 2017. This period equates to an average reserve decline of $42 billion per month. This decline of 10.12% shows that global credit is contracting rapidly, and businesses will begin the process of liquidating investments to pay off previous debts that are denominated in dollars. As the Federal Reserve continues the slow path towards interest rate normalization, the dollar will be public enemy number one. The dollar’s strength will require these debts to be paid back in even more dollars, as major currencies around the world will fall in relation to the dollar. Emerging market economies will not be able to handle this level of debt, and a debt crisis could ensue, much like that of 1998.
Ludwig von Mises said many years ago that once a central bank indulges in the expansion of credit, it has to go on expanding credit by lowering the rate of interest it charges on loans. It cannot stop expanding credit: it has to go on expanding credit by lowering even more the interest it has to set. If the Fed were to relieve itself from the market, the market would determine what the real interest rate would be. This would allow businesses to clear out the mal-investment from the artificial boom. Federal Reserve policy, as is, will and has led to exorbitant asset prices, with eventual debt liquidation.
Once the gold standard was abandoned in 1971, the credit expansion that ensued fed international reserves. A major topic of concern from the Trump administration is the trade deficit. Although the deficits are large and problematic for the U.S., this process liquefies the globe with dollar liquidity. As Mr. Trump closes the spigot on the trade deficit, dollar liquidity around the world will tighten and increase the speed of decline. Rapid decline of these reserves will lead to currency devaluations, high unemployment, capital destruction, political ramifications, and economic chaos.
The International Monetary System’s days are numbered,