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Daniel Lacalle
Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat? (2015), and Life in the Financial Markets (2014).
The summit of the so-called BRICS (Brazil, Russia, India, China, and South Africa) has closed with an invitation to join the group extended to the Emirates, Egypt, Iran, Saudi Arabia, Argentina, and Ethiopia.
The summit has generated a lot of headlines about 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 perceived as a threat to the United States or even the International Monetary Fund.
Several things need to be clarified.
Many political analysts believe that China lends, invests, or supports in return for nothing. China is a major economic power, but it has no interest in being a global reserve currency. Its currency is currently used in only five per cent of global transactions, according to the Bank of International Settlements.
China and Russia have capital controls. It is impossible to have a global reserve currency without freedom of capital movement. More requirements are needed than solid gold reserves 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 rigorous lenders than many politicians think. It seems that some emerging market politicians think that joining China and Russia will be a kind of free money panacea.
Another problem with creating a BRICS currency is that, logically, neither China nor Russia has the slightest intention of losing their national currency to dilute it alongside a group of issuers who have a doubtful track record in controlling their monetary imbalances. Over the past 10 years, the currencies of the BRICS guest countries have depreciated significantly against the US dollar. The Argentine peso has fallen by 98 per cent, the Egyptian pound by 78 per cent, the Indian rupee by 35 per cent, the Ethiopian birr by 68 per cent, the Brazilian real by 55 per cent, according to Bloomberg, and the Iranian rial has collapsed by 90 per cent, 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 per cent against the US dollar, according to Bloomberg) in the last decade has also been poor despite having 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 per cent.
For a fiat currency to be stable, it is necessary that the issuer defend it as a reserve of value, a generally accepted payment method, and a unit of measure. Freedom of capital and independent institutions that provide legal security to domestic and international investors are needed. Having a strong military power does not guarantee a currency accepted as a reserve of value, as demonstrated by the disastrous Soviet kopek, despite the USSR’s influence on half the world.
Joining countries with governments that advocate monetizing uncontrolled public spending and massively increasing monetary imbalances cannot create a stable currency unless they implement the example of the euro. In 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 trying to play 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 greatest fiat monetary success in the post-Bretton Woods era; let us not deprive it of its merit.
The BRICS alternative starts with a major Achilles heel. China and Russia are going to have major difficulties imposing fiscal and monetary policy restrictions on their partners. Let us not forget that several of these partners have joined the group, thinking that from now on they will be able to continue printing money and spending without control, but their monetary imbalances will be distributed to other nations.
The euro has been a success because liberal democracies with independent institutions and broad economic freedom and legal certainty agreed to align their policies for the common good, creating a solid currency that avoided the debacle created by the inflationary spirals that were the norm in Europe historically when governments devoted themselves to transferring their imbalances to citizens’ wages and savings through monetary destruction. This does not seem easily replicable with BRICS and guests.
China, however, can increase its control over all these countries by implementing rigorous monetary and fiscal policies. It is the strongest lender of all the BRICS, but it is unlikely to take on the role of the euro’s Germany, willing to absorb the excesses of others in exchange for a common project. China is going to increase its control over the countries in the group, but it is not likely to jeopardize the stability and security of its enormous population by sinking the currency. The Chinese government is probably analyzing how the euro is losing monetary prudence and reaching the conclusion that it cannot take that same risk with some of these new partners. However, China will probably make the most of its financial strength to lend, increase their domestic and international growth options, and access abundant and cheap commodities.
China is the big winner of the BRICS summit. The Chinese government probably knows that many of its partners are going to continue increasing their imbalances, and this may 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 trigger inflationary imbalances.
Meanwhile, in the US, the government may jeopardize the credibility of the US dollar if it continues to generate deficits of two trillion dollars a year, more than a $14 trillion estimated deficit by 2030, and with an increasing number of irresponsible advisers saying that it can create all the money it wants without risk. The fiscal credibility, institutional independence, and economic freedom of the US dollar, the most widely used currency in the world, cement 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 arrive through competition from another fiat currency, as the temptation of governments to destroy the purchasing power of the issued currency is too strong. It will probably come from independent currencies.
