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While there’s a lot of clamoring by BRICS to challenge the dollar, I believe there are – at a fundamental level – two big problems with a BRICS currency.
First issue: as noted in Part One, almost all of BRICS run current account surpluses (minus India) - meaning they export their excess abroad to the West.
Or said another way, if they want to cut out the dollar – and essentially the West – who will run the deficits required to absorb the BRICS excesses?
They can’t all run surpluses with each other (remember it must balance).
So, from a scale perspective, it would most likely be China to absorb their excess (run the deficit) – thus making them fully reliant on Beijing.
But China doesn’t seem to want to rebalance its economy away from manufacturing to absorb other nations’ exports.
In fact, China recently doubled down on export growth since it can’t get any consumption going domestically.
For instance – in February 2023 – China’s current account surplus hit a 14-year high1 – which was 32% larger than in 2021. And the most since 2008.
Meanwhile – as Brad Setser noted2 – China’s manufacturing trade surplus as a percentage of GDP hit over 10% by the end of 2022 - back at 2008 levels.
This means that the world was effectively absorbing over 10% of China’s manufacturing output that it couldn’t generate domestically.
And to highlight the power the U.S. consumer has for carrying global growth, the U.S. current account deficit (what it imports in excess) is more than the other major deficit nations put together.
In fact – even before3 COVID (2019) – the U.S. current account deficit was roughly the same as the next 19-deficit-running nations.
That’s an enormous number of net imports and consumption due to the U.S. and means that the U.S. alone is creating demand for nearly $1 trillion (as of 2022) in foreign goods.
Now, is it prudent for the U.S. to consume so much more and suffer increased debt burdens?
No. But U.S. deficits keep dollar liquidity flowing globally (because when the U.S. buys more than it exports, it’s putting dollars into the global economy).
And this is a huge reason the dollar has proliferated into the global economy.
Because when the U.S. imports more than it exports, it pays in dollars.
Put simply, the U.S. is selling dollars and collateral (bonds) to those exporters (who are buying dollars).
But China, the world’s largest surplus-running nation, doesn’t net export yuan (since they’re selling more than buying). Thus no one can get the very yuan needed to buy goods at scale.
To put this into perspective – according to Bloomberg – the yuan only makes up less than 3.7%4 of global payments. That’s nothing compared to the dollar’s 46.5% share and the euro’s 24%.
To change this, it would require China to run huge deficits instead, supplying the world with yuan liquidity and bonds (aka China must import more than it exports).
And Beijing doesn’t seem willing to do that.
Hypothetically, How A BRICS Currency System Would Work
Thus, if BRICS wants to cut out the U.S. and the dollar, it will come at a high cost in their export economies. And I don’t believe they have the political stomach for that.
A BRICS currency likely requires all economies to be pegged to one currency and its respective monetary policy.
In a peg system, there must be an anchor economy or system that maintains interest rates and liquidity.
And historically speaking, when countries want to form a currency bloc, they peg to the most economically powerful country with low inflation rates.
For example, when the euro and the European Central Bank (ECB) were created in 1998-99, it was modeled after the German Bundesbank (their central bank at the time) as Germany was the powerhouse of Europe.
This meant that any and all eurozone members (there are 19) using the euro must abide by the policies set by the ECB.
This has caused serious issues between Germany and the rest of the eurozone. Such as:
1. How the ECB aggressively eased policies to support weaker members at the expense of German savers.
2. Or like when Greece needed two hefty bailouts back in 2010-2012, they were at the mercy of the ECB and Germany who gave them loans in return for forced Greek austerity measures.
This meant that Greece and other indebted euro nations were forced to suffer deep recessions. And further austerity made it worse – even though Germany and others were growing (relatively).
If Greece had its own central bank and its former currency – the drachma (pre-2001) – they could’ve avoided ECB policies imposed on them and increased deficits and liquidity instead.
This is a core problem when you lump different economies with different growth agendas and different inflation rates altogether.
So – if a BRICS currency was ever formed – it would most likely be based on China’s monetary system.
But what if China goes into an overheating cycle and looks to tighten liquidity? Yet Brazil was in a recession?
Brazil would want lower interest rates to stimulate while China wants higher rates to cool down. And this would cause a conflict of interest between them (Brazil would be then tightening into a recession, which isn’t popular).
Thus, it wouldn’t make sense for the BRICS to have a single currency as they’re so different. And all would effectively be tethered to China’s boom-bust cycle.
It seems more likely they would instead peg their local currencies to the yuan in a semi-peg system. Meaning their currencies can trade within an XYZ band against the yuan.
But the same issues remain.
If China raises interest rates, strengthening the yuan and draining excess liquidity, all others in BRICS would also have to raise interest rates to maintain the peg (otherwise it will break).
Now, if they have built up yuan reserves, then they can raise interest rates while selling their yuan to buy their own currencies (maintain the peg).
But they’d be bleeding reserves in doing so.
Also, what if one peg is set too high for an economy or set too weak?
For example, if the Russian ruble is pegged at a higher rate than its economy can justify, it will constrict exports, raise imports, and cause chronic deficits – eventually leading to the peg breaking.
Meanwhile, if the South African dollar is pegged at a lower market rate. It will lead to increased exports, but costlier imports and weaker standards of living.
Such a peg system between diverse economies and political agendas could create unfair trade advantages between BRICS and lead to resentment (as we’ve seen in the Eurozone).
What Does All This Mean for The Dollar And U.S. Exports?
I know this may sound technical and potentially high-level (it is). But the balance of payments between the U.S. (deficit) and the BRICS (surplus) doesn’t seem to get a lot of attention even though it’s very important.
But I believe it’s absolutely critical to understand how capital flows and global trade function.
So - to recap - the BRICS have anemic consumers and remain export-driven, dumping their excess goods on the global markets (mostly to the U.S.).
Thus, if the U.S. tomorrow said, “We are going to balance our budget and slash deficits,” the BRICS economies would feel a tremendous decline in growth and liquidity.
In fact, these countries hoard dollar reserves to make sure their currencies remain weak against the dollar (keeping the dollar stronger) to promote exports.
· Remember, a stronger currency means imports are cheaper and exports become less competitive. And a weaker currency does the opposite – hurts imports while making exports more attractive.
To put this into perspective – in a free market system – all the inflows of dollars into China should raise the yuan’s value and decrease the dollar’s value. Thus, creating more import capacity in China and subsequently more exports from the U.S.
But we haven’t seen that. . .
Instead, as of writing this, the U.S. dollar has soared over 30% in the last 15 years (since March 2008) relative to foreign currencies5 - even in the face of massive deficits and huge Federal Reserve easing.
Meanwhile, the Chinese yuan has actually decreased in value against the dollar in since 2014 – even with above-trend growth and huge surpluses.
Figure 1: CNBC, Yuan-to-USD ForEx Rate
Why?
That’s because these export economies – such as China – use a form of ‘currency mercantilism’ – aka hoarding dollar reserves, keeping their currencies weak, and using aggressive government subsidies to promote exports.
And it has come at the cost of their consumers (domestic demand).
But as we learn from history – there is a thing called the law of diminishing returns.
· Meaning, there comes a point when an additional factor of production results in a lessening of output or impact.
And China seems to have hit that point in its current economy (just as Japan did thirty years ago).
Thus, if BRICS is ever serious about actually de-dollarizing, they would have to completely rebalance their economies.
This means a focus on allowing their currencies to strengthen (promoting imports). Stimulate domestic consumers (lower the savings rates and spur household borrowing). And stomach-increasing deficits.
But what’s most ironic is that a BRICS currency would likely help the U.S. – as it would mean the U.S. could manufacture and export more abroad through a weaker currency, narrowing U.S. deficits.
Now, it could happen. But it doesn’t appear China wants to trade their export economy and deal with the painful rebalancing to subsidize BRIS and even U.S. manufacturing.
We hear many pundits say, “How long can the U.S. deficits remain?”
I would flip that question and ask, “How long can the global surplus-running nations remain?”
Since 2012, three of the four largest economies – China, the Eurozone, and Japan – all run net-current account surpluses. Indicating extremely anemic domestic consumers. And thus, why they’re all stuck between slowing growth and relative deflation.
This has put ever-greater pressure on the U.S. and its consumers to drive global consumption.
But it’s clear that this absorption of the rest of the world’s gluts has come with negative effects on consumers long-term (such as debt).
So, until we see any of this change, I believe the BRICS currency idea is flawed.
Now, who knows what will happen?
But it doesn’t seem like such a likely (or simple) thing to happen when you sit and dig through the weeds. . .
Sources:
3. https://en.wikipedia.org/wiki/List_of_sovereign_states_by_current_account_balance
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