A secret meet where dollar was Shanghaied!!

The US dollar has just been knocked down and forced to serve the interests of the world against the will of the American people. The dollar has been Shanghaied! The term "Shanghaied" refers to the 19th-century practice of sailors forced to serve against their will on vessels bound for Shanghai. Tactics used included kidnapping and trickery. In the 19th century, trade between the US and China was booming. But there was shortage of able-bodied seamen to sail the cargo vessels. Each vessel had a boarding officer whose job it was to find the crew. Boarding officers were paid by the number of bodies they could round up. This pay was called "blood money".

A common tactic was to confront a seaman in a dark alley, knock him unconscious, forge his signature and drag him aboard. The seamen would regain consciousness after the vessel left port. There was no choice but to finish the journey or jump ship. Most finished the journey. Next stop — Shanghai! Based on the best information we've been able to obtain, it looks like the dollar has just been Shanghaied by the G-20 (the unelected, unaccountable group of 20 nations that collectively control the world monetary system). This could be the most important financial development of 2016, with enormous implications for your portfolio. This new effort to knock out the dollar was contrived at a secret meeting in Shanghai on February 26.

WHO ATTENDED THE MEETING?

The list of names reads like a rogues' gallery of central planners and currency manipulators. Janet Yellen from Fed, Christine Lagarde from IMF, Mario Draghi from ECB and US Secretary of Treasury Jack Lew were there, along with their central bank and finance ministers from Japan, China and BRICS. The main meeting of G-20 finance ministers and central bank governors was no secret. A side meeting of a core group comprising the US, Europe, Japan, China and the IMF was a secret. This group calls the shots.

The US, Europe, Japan and China together represent over 70% of global GDP. The IMF acts as a facilitator for these secret meetings, and an "enforcer" for agreements reached behind the closed doors. The outcome of this secret side meeting was the biggest dollar take-down operation since the Plaza Accord of 1985.

THE PLAZA ACCORD

The Plaza Accord was orchestrated by James Baker, who was Ronald Reagan's secretary of Treasury at the time. The dollar increased almost 50% between 1980 and 1985, and reached an all-time high that year. The strong dollar was hurting US exports and jobs. The Plaza Accord was a coordinated effort by the US, France, West Germany, Japan and the UK to weaken the dollar. The dollar fell 30% over the next three years. The USeconomy got a second wind, and the Reagan-Bush expansion continued.

Now the dollar is at a 10-year high on major indexes. It's time to trash the dollar again. But the US does not have the same skillful leadership we had in James Baker. This time, the big winner won't be the US; it will be China. The losers will be the same — Japan and Europe.

Understanding these backroom machinations requires some analysis.

CURRENCY MANIPULATIONS

Currency manipulations are negativesum games. One country can get a small temporary boost from devaluation, but trading partners are worse off, and the world is worse off. Ultimately, even the country that devalued first is worse off after others retaliate.

A new theory of currency manipulation was created by Ben Bernanke which says that if every country eases at the same time, everyone gets the benefit of easing, but exchange rates don't change because of coordinated timing. Bernanke called this "enrich thy neighbour," in contrast to "beggar thy neighbour" name given to currency wars in the 1930s.

Cooperation and coordination among central banks can be carried several steps further. Several countries can ease or tighten at the same time to give one country some relative benefit by design. Central banks can give targeted relief to one country if they all cooperate in a secret plan.

Central bank policy changes work through expectations as much as action. In traditional policy, a central bank eases by cutting rates or tightens by raising rates. But it can also ease by raising expectations about a rate increase and then doing nothing.

If markets price in a rate increase and the central bank does nothing, markets can rally on the news. This is like an invisible rate cut, based on changed expectations. Having multiple central banks manipulate expectations and coordinate policy behind the scenes is complex. These efforts are doomed to fail because of unintended consequences and exogenous shocks. But that won't stop the big brains from trying.

CHINA AND EXPECTATIONS

This brings us to China's shock devaluation of the yuan last August. Because China had not managed expectations, this shock destabilised the global financial system. The IMF and Fed were quite upset that China was not playing by the rules of the game.

China did not care about the rules, because their economy was sinking under bad debts and capital outflow. With this and the yuan shock, the global financial powers descended on Shanghai in Feb.

The G-20 central bankers and finance ministers agreed that China needed help. It's the world's second-largest economy and it was falling. There was danger it could take the world down with it.

Further yuan devaluation was not possible (in short run) because it was destabilising to markets. The solution is to weaken yuan on a relative basis by strengthening the currencies of China's trading partners, Japan and Europe. If the yen and euro get stronger, that's the same as making the yuan weaker, but without the shock of Chinese devaluation.

Since this secret deal was worked out on February 26, the first chance the central bankers had to put their plan into action was mid-March.

TRIO'S STRATEGY

The ECB met on March 10. The Bank of Japan met on March 15. The Fed met on March 16. All three would be able to implement the secret plan in just five business days. It was "game on" for the biggest currency manipulation since 1985. Yet how could Japan and Europe tighten without explicitly raising rates? They did it by raising expectations.

Markets thought Draghi's ECB "bazooka" would be long lasting. Markets expected Kuroda of the Bank of Japan to do more aggressive QE. In fact, Draghi did the minimum necessary, and then said he was done doing more. Kuroda did nothing. Both decisions acted like tightening relative to expectations.

The euro and yen went up against the dollar. Comparatively, the yuan went down with no devaluation by China. This was the new Shanghai Accord in action. The dollar declined 30% after the coordinated action at the Plaza Accord in 1985.

The dollar's recent strength since the alltime low in 2011is also shown. This is the period leading up to the new Shanghai Accord, also shown. Will the dollar plunge 30%, as it did after 1985? It might. If that happens,US stocks will get a lift, Japanese stocks will get crushed and gold will soar.

FED'S TACTIC

The Shanghai Accord will be a game changer depending on how hard the insiders push their new playbook. The Fed took a different tack in this plan.

Markets pay attention to the yuan/dollar cross-rate; that's the one the Chinese government manipulates. The yuan/euro and yuan/yen cross-rates just go where they go based on euro/dollar and yen/dollar crosses. The dollar cross-rates are the ones markets pay most attention to.

So the Fed weakened the dollar with their dovish comments at the March 16 meeting. (By doing nothing and signalling slower tightening, they changed expectations, which is a form of ease.) With Europe and Japan tightening and the US easing at the same time, nobody noticed that China devalued, because the yuan/dollar cross-rate was unchanged. Europe is a larger trading partner to China than the US, so the yuan/euro crossrate is actually more important to the Chinese economy. What happened under the Shanghai Accord was a coordinated devaluation that went unnoticed because China took no official action and the yuan/dollar cross-rate was unchanged. It was an invisible devaluation of the yuan.

The US and China are the world's two largest economies. If they go down, the whole world goes down with them. Both economies were showing signs of weakness. It was time for Europe and Japan to give it up to China and the US. That's the legacy of the Shanghai Accord.

WHAT'S NEXT?

There's another secret G-20 meeting on April 16, 2016. This will take place on the sidelines of the IMF spring meeting in Washington DC. At the April conclave, I expect the Big Four (Japan, US, the eurozone and China) to leave exchange rates alone. They'll want time to evaluate their work following the Shanghai Accord.

The Big Four may later want to run the Shanghai playbook again just to give China breathing room. The Shanghai Accord seems like a success for central banks. This means the Big Four will want to try it again to ease financial conditions in the US and China. They won't push it, because Japan and Europe are fragile. For now, a stronger yen and stronger euro are on the cards. The Shanghai Accord happened in stealth, but it will go down in history as a major turning point in the international monetary system.