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Brickbats for the Dollar from the BRICs

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John Robertson

The BRICs - Brazil, Russia, India and China - are trying to flex their economic muscles as their leaders gather in Russia but brickbats directed at the U.S. dollar will probably count for little.

In the lead-up to the BRIC summit meeting, Russian finance minister Alexei Kudrin threw fuel on the debate about the future role of the U.S. dollar by flagging a diversion of funds from U.S. dollar denominated securities to bonds issued by the International Monetary Fund (IMF).

Russian president Medvedev has also argued for currency swap arrangements between China and Russia to facilitate bilateral trade and bypass the use of the U.S. dollar.

Medvedev has also supported use of Special Drawing Rights (SDRs), the IMF synthetic currency, as part of a Russian onslaught against the primacy of the dollar.

There is a widening consensus that some changes must be made to the international financial organizations put in place in the 1940s and which no longer reflect the world as it is today. But, for better or worse, the U.S. economy remains the biggest on the planet and likely to have a role reflecting this status.

Brazil, Russia and India are approximately 10% smaller than the combination of Germany, France, Italy and Spain. China is in a different category because it has shown that it can grow sufficiently fast over a long enough time to gain critical mass. The other members of the group still have some way to go before their actual performance matches their aspirations.

No doubt the rest of the world would like an alternative reserve currency from which to choose. Some countries are motivated purely by economic nationalism. More rationally, some of the opposition to the dollar comes from a view that the global monetary system will be made more stable by reducing the world's reliance on a single currency.

The international monetary system, based around the U.S. dollar, has an in-built flaw. This flaw was identified and discussed extensively among economists and policymakers as long as 50 years ago. Yale University economist Robert Triffin is credited with highlighting the problem.

Triffin described how the U.S. economy would have to maintain current account deficits if dollar supplies were going to be sufficient for global transactional needs. However, persistent deficits risked a loss of confidence in the dollar eventually leading to its failure as a reserve currency. In Triffin's mind, its eventual demise was a systemic feature of the prevailing monetary arrangements.

So far, this has not happened. The potential substitutes have not fared well. When the U.S. seemed most vulnerable and the dollar most at risk of being replaced, everyone else was similarly suffering. Sterling, yen and euro have not been acceptable replacements. For all its problems, the size, dynamism and growth of the U.S. economy have underpinned the dollar's reserve currency status.

Owning the reserve currency delivers status and prestige but any other country's currency will suffer the same fate as the U.S. dollar, eventually. A new reserve currency will only be sustainable if it can supply sufficient liquidity to maintain the needs of the global economy. That means a national economy big enough and structured to run a persistent current account deficit with a freely fluctuating exchange rate and a strong commitment to a liberal international trade regime.

Some countries might meet one or two of these tests but not all of them. Ultimately, there will also be a more practical test. Will Brazil want to hold its wealth in Chinese assets or vice versa? Will Russia prefer Indian rupees to U.S. dollars?

The Russians have helped to precipitate a surprise return to the spotlight for Special Drawing Rights. SDRs were an artifice manufactured by the IMF in 1969 as an alternative global medium of exchange. Its introduction was initially prompted by a fear that U.S. dollars would not flow in sufficient numbers. By the mid 1970s, this was no longer a problem and, over time, the SDR lost its profile as a practical alternative currency.

The SDR is a mix of currencies which moves the world only marginally away from a dependence on the U.S. dollar. Russia, with approximately 45% of its reserves in US dollar denominated assets, will achieve little diversification benefits from moving to use of the SDR. Currently, the U.S. dollar comprises 44% of the value of a SDR, the euro makes up 34% and the yen and sterling each contribute another 11%.

In declaring its support for the SDR and the IMF, Russia is probably not upsetting U.S. Treasury boss Timothy Geithner greatly. The IMF currently receives some 17% of its funding from the USA and less than 3% from Russia. The U.S. is reluctant to boost its contribution and is likely to be quietly pleased to see the BRICs play a more substantial role in funding international financial organisations, including the IMF.


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