7 minute read
*This was our recent issue of the Saturday 'Morning Pour' to email subscribers.
Over the last few months, we’ve seen a wave of hysteria regarding ‘de-dollarization’ and the formation of a BRICS currency. And many investors and clients may be spooked about this.
Now, what do I mean by de-dollarization?
Simply put, it’s the concept that the global economy is moving away from the dollar and U.S. bonds.
But let’s be clear – I believe BRICS is simply:
- A diminishing growth engine in China (the C).
- A golden goose that’s never laid an egg - but has potential - in India (the I).
- And three anemic commodity producers in Russia (R), Brazil (B), and South Africa (S).
Headlines like “Argentina Ditching Dollar” and “Saudi Arabia Moving Towards Chinese Yuan” and “Brazil Declares War On Dollar” have spread like a fire.
But I don’t buy the hype.
Why?
Because there are imbalances within the BRICS economies - such as they all essentially run current account surpluses (except India). Have extremely high domestic savings rates. And - I believe - would most likely depend on the Chinese economy and the yuan as the backbone of a currency bloc.
This may sound like a mouthful, but I’ll explain why these things truly matter when trying to envision a BRICS currency and economic union.
Now, it’s not impossible for a BRICS currency to happen. But it would require a hefty amount of pain that these countries likely don’t want to endure.
Or rather, it’s not as easy as many mainstream talking heads claim. It would completely upend their economies and trade flows to switch from dollar reserves to their own BRICS currency.
There’s a reason even after all the de-dollarization talk, the dollar keeps getting stronger and used more in global payments.
Now, keep in mind this is a complex macroeconomic topic (although grossly underrated). And I don’t plan on covering everything.
But these are important topics that not many seem to discuss regarding a BRICS currency.
So, let’s take a closer look at all this and why it matters. . .
Why Current Account Surpluses Are a Problem for BRICS
In economics, it’s generally taught that a country running a current account surplus (exporting more goods and savings than it imports) is a ‘good’ thing. And that a deficit (importing more goods and savings than it exports) is ‘bad’.
But I don’t look at things so black and white - especially in economics and markets.
Instead, it’s just a balancing act – neither good nor bad.
A better way to think of it is that balance of payments (BOPs – global deficits and surplus measures) are basically accounting for countries - meaning a surplus in country A is a deficit in countries B or C or D, etc. (and vice versa).
So – for example – if China runs a surplus, that necessarily means some other country ran a deficit.
Now, why does this matter?
Because currently, almost all BRICS run chronic current account surpluses (with India potentially moving towards one1).
How BRICS Economies Depend on Western Deficits
Meanwhile, the U.S. and U.K. run large current account deficits to match these (remember, it must balance).
For perspective, the International Monetary Fund (IMF) recently noted2 in 2022 the evolution of global current accounts (as a percentage of world GDP) after the Russia-Ukraine war began.
And as you can see, not only do they balance. But has actually widened since 2020 (but is expected to narrow in the coming years according to the IMF).
Seems ‘good’ for BRICS, right?
Well, not so fast.
These current account surpluses also indicate that BRICS (and Germany, Saudi Arabia, and Japan) have unbalanced economies.
What I mean is, they aren’t consuming what they produce, thus needing to export the rest abroad (hence the surplus).
Another way to put this is that these current account surpluses show us that BRICS have low domestic demand. And thus, depend on the Western economies to import their glut of goods and savings for growth.
In fact, according to Investopedia3, a current account surplus indicates, “low domestic demand, or may be the result of a drop in imports due to a recession.”
These chronic BRICS surpluses indicate two things:
Low Domestic Demand: The Achilles' Heel of BRICS
Just look at the World Bank’s household financial consumption expenditures (HFCE – aka consumer spending) as of the end of 2021.
There’s a thick gap between consumer spending in the BRICS compared to the U.S.
To put this into context, U.S. consumer spending is nearly $16 trillion – which is 50% more than all of BRICS put together ($10.8 trillion).
The consumer classes in BRICS just don’t have enough purchasing power to absorb all of what they produce and therefore depend on exports.
Thus, if it wasn’t for the deficits (excess buying) in the West, these economies would likely drown in deflation and unemployment as all their unconsumed goods sit idle (which is what we’ve seen happen in China over the last 10 months).
Or – putting it plainly – they depend on their exports to the West for growth and foreign reserves at the expense of their own anemic consumers.
High Savings Rates in BRICS: A Double-Edged Sword
Note that other major current account surplus nations4 – such as Germany, Japan, South Korea, and Saudi Arabia – also have very high savings rates.
Germany is at 26%. Japan is at 25%. South Korea is at 35%. And Saudi Arabia is at 29%.
These numbers dwarf the U.S.’s 17% and U.K.’s 15% savings rates.
Keep in mind that households can only do two things with income – dissave (consume) or save (not consume).
And when there are more domestic savings on a national level, it means less consumption.
In fact, many of these BRICS and emerging economies depend on high savings (low consumption) policies to fuel export growth.
This is known as the Gerschenkron growth model5 – named after classical economist Alexander Gerschenkron.
He essentially wrote that the more backward an economy is at the outset of development, the more likely certain conditions will occur.
These include:
- Government-controlled banks that channel physical and human capital into specific industries (such as oil or manufacturing).
- A focus on producer goods rather than consumer goods.
- An emphasis on agricultural/commodity sectors as a market for new domestic industries will be small.
- More capital-intensive production rather than labor-intensive production (focus on capital for returns rather than labor efficiency).
Do all sound familiar?
This is what China, Russia, Brazil, South Africa - and even Japan, Saudi Arabia, and Germany - have done to some extent.
Thus, the high savings turn into less domestic consumption, which creates a larger current account surplus (lower imports to consumer while exporting more) – translating into more dollar reserves in state coffers.
Why BRICS May Struggle to Break From the Dollar
And what do they do with these dollar reserves? They buy U.S. bonds as collateral (yield) and often use it to keep their currencies weak against the dollar – making sure export growth continues.
I know this may sound technical, but the gist is that BRICS depend on others to absorb their excess exports – mostly the Western countries (such as the U.S.).
Or rather, if Washington suddenly said it’s going to balance the budget (limit deficits), these surplus countries would feel it harshly – potentially even worse than the U.S.
Thus, breaking from the dollar would completely force these nations to rebalance their economies. Something they do not seem willing to do thus far. . .
What Does the Future Hold for the U.S. Dollar?
Now, I’ve covered some high-level issues of BRICS so far. And these are things that many haven’t talked about but must be answered (after this you have some great context to share with clients or investors).
You may be thinking, “what does this mean for the U.S. dollar and global economy?”
That’s a great question – because this could have strong implications for global trade and investment portfolios.
But I’ve already touched on a lot here – so I am going to cover all that in Part Two, which comes out in next week’s Morning Pour (subscribe to our email list to receive it Saturday morning).
What I’ll go over is:
- How even with surging deficits and Federal Reserve easing since 2008, the U.S. dollar has gotten stronger compared to BRICS currencies. Meanwhile, countries with chronic surpluses have seen their currencies decline.
- How a BRICS currency would even work if they decided to do it. And why it would be potentially more difficult than how the euro turned out.
- Why BRICS depend on the dollar and U.S. consumer – and how creating a new currency can’t change that alone.
- Which countries would potentially benefit from a BRICS currency, and which wouldn’t (the answer may surprise you).
So, stay tuned. . .
Sources
- https://www.orfonline.org/expert-speak/indias-current-account
- https://www.imf.org/en/Blogs/Articles/2022/08/04/blog-global-current-account-balances-widen-amid-war-pandemic-080422
- https://www.investopedia.com/terms/c/current-account-surplus
- https://worldpopulationreview.com/country-rankings/savings-rate-by-country
- https://en.wikipedia.org/wiki/Backwardness
Disclosure
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice or an investment recommendation, or as a substitute for legal counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.