Wednesday, June 10, 2009

The US Dollar and the Brics - A Love and Hate Affair

According to Bloomberg, the BRICs are buying dollars at the fastest pace since before credit markets froze in September, protecting exports even as leaders of the biggest emerging markets consider alternatives to the U.S. currency.. Indeed, Brazil, Russia, India and China increased foreign reserves by more than $60 billion in May to limit currency gains as the first global recession since World War II restricted exports, data compiled by central banks and strategists show. Brazil bought the most dollars in a year, India’s reserves gained the most since January 2008 and Russia added the most foreign exchange since July. The reversal of capital flows back to emerging markets has led to an increase in central bank intervention to slow appreciation of their currencies.

While Russian, Chinese and Brazilian leaders suggest substituting the dollar, the central bank purchases show just how much these countries still rely on the dollar. Russia is proposing the BRICs consider creating a new unit of exchange when they meet in Yekaterinburg on June 16. China and Brazil said last month they may look at ways of dropping the dollar for trade between the two countries.

On the other end, China is proposing an overhaul of the global monetary system, suggesting that the U.S. dollar could eventually be replaced by the IMF's Special Drawing Right (SDR) as the world's main reserve currency. It seems that China is considering buying bonds issued by the IMF to boost the institutions capital. These statements come as China has expressed increasing concern about the long-term value of its US assets and has taken several steps to gradually increase the international role of the RMB.

Similar to what happened last month, when Brazilian president Lula proposed the use Brazilian and Chinese currencies when China and Brazil were trading, it seems that now, the proposal has gained Russia´s acceptance. The idea would be to create regional currencies as way tto shift away from the dollar.

In our view, it is clear that the attempts to create regional currencies display the countries´disappointment towards the US poor performance. It also poses a (non credible) threat towards the long term stand of the US dollar as a universal medium of exchange, store of value and unit of account. On the other end, we notice that these same countries that are trying to stay away from the dollar are also increasing its international reserves, that are mainly dollar based. So, it will still take time for the world to find another universal medium of exchange that is as liquid as the US dollar.

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