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Tuesday June 16, 2009 - 20:03:48 GMT
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Forex Blog - BRIC Drops like a Feather Not Hardened Clay

Since when did two of the world’s largest exporters of raw materials ever want to partner up with two of the world’s largest importers of raw materials to forge an alliance to master the global economic and geopolitical universes?  Brazil, Russia, India and China have very little in common…apart from a long history of border tensions - China, India and Russia - China shares borders with both India and Russia and they are still in dispute.

What they do have in common is a huge habit of buying dollars to prevent their respective currencies from appreciating versus the USD brought about by a desire to export finished goods and commodities to the rest of the world and profitably.

By managing exchange rates versus the USD (and EUR in the case of Russia) and selling lots of commodities and finished goods to the US and world economies, they have huge stockpiles of greenbacks.  And now with the Fed fully engaged in printing money (it pledges is temporary and will be reversed) and the US government running massive deficits, this Jim O'Neill defined amalgamation of otherwise individual states have US dollar and US asset exposure to worry over, and together today.

They also have a shared desire to have a larger say over the running of multilateral institutions like the IMF and UN and bring their influence in line with the relative size of their economies which in the case of the IMF voting rights system means developed states must give up some voting rights to BRIC to address one of its chief grievances.

Ironically the US and G7 are relatively warm about increasing the voting rights of BRIC at the IMF (less clear about who gives up voting shares) as long as BRIC takes on the responsibility of a major stakeholder in institutions like the IMF.  This means allowing currencies to float freely, open markets, share financial data (disclose) for security purposes, respect property rights and use policy to diversify their economies - apart from India they are one-dimensional.

While BRIC heads of state avoided any public flogging of the dollar as the preeminent reserve currency, they did say that the issue would be studied by central bankers and finance ministers during the interim before the 2010 summit in Brazil (second ever).

When BRIC (India least guilty) raises mercantilism to a founding principle for modernization, it is awfully hard to quit.  China today (I wonder what BRI thinks…and not the cheese?) introduced a Buy China policy for its fiscal stimulus (guess it liked what US Congress did with the Obama stimulus) which requires all government stimulus money at every level of government to buy Chinese made products and services before procuring them from foreign suppliers.  All for one and one for one...rallying call for the Four BRICeteers 

Mercantilism means accumulating dollars and at a rapid rate, especially when the USD is under downward pressure like it was in the month of May.  Indeed the USD index fell over 6% in the month, the most for any month since the post-Plaza decline in 1985.  What happened to BRIC reserves in May? They jumped $60bln (assuming mainly from buying dollars to prevent local currencies from rising much).  And according to H.4.1 data from the Fed, in May US Treasury holdings of foreign central banks rose $68.8bln, nearly a record for any single month. 

In terms of total foreign reserves excluding gold, Brazil has around $205bln, Russia has $438bln, India $310bln and China $1.95trln for a total of around $2.9trln or roughly 42% of the world's reserve currencies. Houston we have a problem. Moreover, according to the IMF the share of USD reserves of the world's total rose to 64% at the end of 2008 up from 62.8% in June of 2008.  Diversification may be happening but it is at a snails pace and in the meantime the share of USD reserves at best is growing less fast, but us still growing (suspect May killed the less fast speed). 

Don't get me wrong I would be having a rough time sleeping on a USD long of the BRIC order and would want every assurance that the US Fed and government would not turn to Zimbabwe printing presses to inflate their way out of the debt burden (what aging society in the developed world is not facing this dilemma to one degree or another?).

One can imagine that any rational private or government investor in US Treasuries and the dollar is righteously worried and deserves two road maps with specifics on how accommodation will be exited. For obvious reasons many are willing to give the Fed the benefit of doubt as the central bank has an okay track record on containing inflation since former Fed Chairman Volcker shot and killed inflation in the late 1970's and early 1980's. And the record since has been fair…poor to dreadful on bubble prevention and F- on bank regulatory oversight. But the US government - this includes the Congress and not just the White House - has a spotty record at best at cutting deficits and increasing public savings.  Counting on growth and good times to pay for a hamburger today is no way to live.  And counting on a macro technical innovation that reaps all sorts of new wealth and returns (and tax receipts) is almost like waiting for the tooth fairy to balance the budget.  The US is vulnerable and especially so to the whims of US Congress and White House - it takes a huge leap of faith to assume they will rise to the occasion.  President Obama certainly seems up to the job, but rhetorical flourishes is a far cry from delivering and there are endless hurdles between sound bites and higher taxes (inevitable – ideally when economy is well into recovery) and spending cuts (not talking earmarks...statistically insignificant).

But BRIC as a viable counterweight to G7 (remember G8 includes Russia - can see its divided loyalties when read Finance Minister Kurdin's pledge to keep buying Treasuries and the dollar on Saturday after the conclusion of G8 in Lecce, Italy) at this stage is laughable.  Can almost imagine the dinner is dreadful what the US is doing to its fiscal position and currency and oh by the way do you still have several divisions of troops on our border? 

Just because the USD has a kick-me Post-it stuck to it does not make for a viable alternative reserve currency now or for the next 10 years at least. And dare I say this entire period of second guessing the dollar will be quickly forgotten if the Fed and Treasury manage to thread the needle and exit accommodation in a credible way that prevents easy money and debt-financed attempts to buy growth and stave off deflation from leading to a serious inflation problem (see Triffen Dilemma article below).

So it is correct to be somewhat dismissive of BRIC dollar threats and see them for what they are disingenuous. Yet BRIC is increasingly the bank to the US government (and private sector) and not even a bank that has allowed its chief customer to run up a mountain of debt will keep going because it does not want to risk bankruptcy and massive losses 

Oh by the way US Treasury has been virtually silent on this entire at time public debate among BRIC states.  Maybe it knows as the Fed surely does that there is precious little time to come up with a detailed exit strategy that could silence dollar critics (and selling pressure) for some time to come.

David Gilmore



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