By Daniel Lacalle
The summit of Brics countries (Brazil, Russia, India, China and South Africa) was recently concluded with an invitation to join the group which was extended to the United Arab Emirates, Egypt, Iran, Saudi Arabia, Argentina and Ethiopia.
The summit drew many highlights on the impact of this widespread group of nations, including speculation about the end of the US dollar as a global reserve currency if this group is seen as a threat to the US or even the International Monetary Fund.
Several things need to be clarified in the view.
Many political analysts believe that China lends, invests or supports without any conditions. China is a major economic power, but is in no way interested in being a global reserve currency. Its currency is currently used in only 5% of global transactions according to the Bank of International Settlements.
China and Russia both have strict capital controls. It is impossible to have a global reserve currency without freedom of capital movement. More than solid gold reserves are needed to have a stable fiat currency. It is essential to guarantee economic freedom, investment, legal security and the free movement of capital, as well as an open, transparent and diversified financial system.
China and Russia are much more demanding and strict lenders than many politicians think. It seems that some emerging market politicians think that joining China and Russia will be some sort of free money panacea.
Another problem with creating a Brics currency is that, logically, neither China nor Russia have the slightest intention of losing their national currency only to dilute it with a group of issuers with a dubious record of controlling their monetary imbalances. not.
Over the past ten years, the currencies of the Brics member countries have weakened significantly against the US dollar. The Argentine peso fell by 98% according to Bloomberg, the Egyptian pound by 78%, the Indian rupee by 35%, the Ethiopian birr by 68%, the Brazilian real by 55%, and the Iranian rial collapsed by 90% according to The Economist. Putting together weak currencies does not create a strong currency.
We must not forget that the performance of the Russian ruble (-68% against the US dollar, according to Bloomberg) was also poor in the last decade despite a relatively prudent central bank.
The best “Brics and guests” currency against the US dollar in the last 10 years is the Chinese yuan, with a depreciation of only 14%.
For a fiat currency to be stable, its issuer must defend it as a reserve of value, a generally accepted method of payment and a unit of measure. Freedom of capital and independent institutions that provide legal security to local and international investors are needed.
Having a strong military force does not guarantee a currency that is accepted as a reserve of value, as demonstrated by the disastrous Soviet kopeck, despite the USSR’s influence over half the world.
Joining countries with governments that favor monetization of uncontrolled public spending and massively increasing monetary imbalances cannot create a stable currency – unless they implement the example of the euro.
For the euro, Germany, the country with the most prudent and responsible fiscal policy, dictated the main lines of the monetary and fiscal rules for the rest. Unfortunately, the eurozone and the ECB, in their attempts to be the US and the Federal Reserve, have lost most of their options to be a real alternative to the US dollar. And the euro is the biggest fiat monetary success in the post-Bretton Woods era – let’s not deprive it of its merits.
The Brics alternative starts with a big Achilles heel. China and Russia are going to have great difficulty imposing fiscal and monetary policy constraints on their partners. Let us not forget that several of these partners have joined the group, thinking that henceforth they will be able to print money and spend without limits – but their imbalances will be spread to other nations.
The euro was a success because liberal democracies with independent institutions and broad economic freedom and legal certainty agreed to align their policies for the common good. A sound currency was established to avoid the debacle created by the inflationary spirals that were historically the norm in Europe when governments devoted themselves to transferring their imbalances to citizens’ wages and savings through monetary destruction. This does not seem easily repeatable with Brics and partners.
However, China can increase its control over all these countries by strictly implementing a monetary and fiscal policy. It is the strongest lender of all the Brics countries. It is unlikely, however, that it will assume the role of the euro’s Germany, which is prepared to absorb the excess of others in exchange for a common project.
China will increase its control over the countries in the group, but is unlikely to threaten the stability and security of its enormous population by sinking the currency. The Chinese government probably analyzes how the euro is losing monetary prudence and concludes that it cannot take the same risk with some of these new partners. However, China is likely to use most of its financial strength to lend, expand its domestic and international growth options, and gain access to abundant and cheap commodities.
China is the big winner of the Brics summit. The Chinese government probably knows that many of its partners will continue to widen their imbalances, and this could allow China to strengthen its leadership position. However, I find it hard to believe that China will agree to the creation of a currency that others can use to cause inflationary imbalances.
Meanwhile, the government in the US could jeopardize the credibility of the US dollar if it continues to generate deficits of two trillion dollars a year, more than an estimated deficit of $14 trillion by 2030, and with an increasing number of irresponsible advisers who say that they can create all the money they want without risk.
The fiscal credibility, institutional independence and economic freedom of the US dollar – the most used currency in the world – confirm its leadership. If the government undermines these strengths, the dollar will lose its reserve status.
The end of the US dollar, if it comes, will not be driven by competition from another fiat currency, as the temptation for governments to destroy the purchasing power of the issued currency is too strong. It will probably come from independent currencies.
- Daniel Lacalle is a professor of global economics at the IE Business School in Madrid and author of Freedom or Equality, Escape from the Central Bank Trap, The Energy World Is Flat and Life in the Financial Markets.
This article was published courtesy of the Mises Institute in the USA.