How could the BRIC nations create a financial instrument to replace the dollar in international trade?
Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Distinguished Research Professor of Economics at the University of Missouri, Kansas City.
Cross-posted from Michael’s blog
This first week of October has seen U.S. interest rates soar to the 5% level on long-term Treasury bonds. That has made long-term Treasuries one of most attractive investment vehicles in the world, or even the most attractive.
One obvious result is that countries aiming to dedollarize their central-bank reserves would make an untimely decision move out of the dollar at this point. To avoid holding dollars in the form of US Treasury securities would mean holding foreign reserves denominated in a currency that is declining against the dollar. No other government is willing to make its currency so attractive to international investors (including central banks) by raising interest-rates so high.
At 5%, US bonds are the most secure and best investment around. There is a huge move into the dollar – and hence, pushing up its exchange rate against most other currencies. That has made it much more expensive for Global South countries to service their foreign debts denominated in dollars to the IMF, World Bank and private bondholders. If they try to pay these debts – which are now much more expensive in their own currencies – they will have to suffer austerity, and use their economic surplus to pay dollar-holders instead of using it to develop their own economies.
That strain imposed by international debt service is the most serious since the late 1920s – with the same refusal of creditor countries to see how today’s foreign-debt overhead cannot be paid. We have seen this before, in the austerity caused by Germany trying to pay its World War I reparations debts, and by England and France trying to pay their Inter-Ally debts despite the self-destruction of adhering to creditor demands.
The world refused to negotiate a write-down of these inter-governmental debts until the 1929 crash forced realistic observers to agree to the 1931 moratorium on German reparations and Inter-Ally debts. By that time the Great Depression was underway.
Today’s 5% interest rate threatens to destabilize the domestic US economy and federal budget just as much as it is increasing the cost of debtor countries servicing their foreign dollar bonds. A 5% interest rate on 30-year bonds means a doubling time in 14 years. (The Rule of 72: Divide 72 by the interest rate to get the doubling time.) For a 30 year bond, a million-dollar purchase will quadruple in face value, to $4 million by the time the bond matures in 2053, thirty years from now.
Think of the effect that this will have on the US budget by that time. A much larger share will have to be allocated to pay bondholders – most of whom make themselves tax-exempt, for instance by holding their savings offshore.
The world’s debtor countries, if not the creditors, are finally coming to realize that many government debts can’t be paid – except by throwing their economies into depression and austerity. That might be in store for the US economy too if it tries to tax the economy to pay creditors instead of simply printing the money.
Obviously there needs to be an alternative. It needs to be beyond merely the first step of declaring a debt moratorium. A longer-term restructuring of the international financial system is needed, because the present system has become dysfunctional.
This recognition has been most explicit by the statements of China’s and Russia’s government. Although they are positioned to become creditor countries in the coming world realignment, they recognize the need to create a way for countries to run balance-of-payments surpluses or deficits without polarizing the international economy between creditors and debtors, creating a new split such as is now occurring.
At Thursday’s Valdai Club meeting in Sochi, Russia’s President Putin explained how he viewed the needed restructuring. Contrary to much discussion in the West, what is planned is not a “BRICS currency,” but something much more limited: a means of settling payments imbalances along quite different lines from those that have led to today’s crisis.
As far as BRICS is concerned, we don’t need to create a single currency, but we need to set up a settlement system, create financial logistics in order to ensure settlements between our countries, switch to settlements in national currencies, while understanding what is happening with our national currencies, and keep in mind the macroeconomic indicators of our economies. Exchange rate differences, inflationary processes. …
I have already said, and many believe, that the Bretton Woods system is outdated. After all, this is not me talking, these are Western experts. It needs to be changed. Of course, it leads to such ugly phenomena as, say, debt obligations of developing economies, of course, this is the absolute, complete domination of the dollar in the world system. It’s only a matter of time before this happens.
What is needed certainly is not a “new Bretton Woods.” The old Bretton Woods system was designed in 1944 by US planners first and foremost to break down Britain’s Empire Preference based on block sterling holdings (government reserves that could not be spent outside of the Sterling area) and the prospect of depreciation of the pound sterling. US planners consolidated American power by basing international monetary policy on the asset that the US Treasury held: gold, of which the U.S. held ¾ of the world’s monetary gold reserves by 1950.
Along with the insistence on free trade and free capital movements (ie. no capital controls or restrictions on how India and other British Empire countries could spend their accumulation of sterling reserves during World War II), the US “rules-based order” turned British sterling into a satellite currency. Having obtained British acquiescence, the US Bretton Woods proposals were imposed on Europe and other countries. Their fate has followed that of Britain’s domestic budget squeeze and “stop-go” austerity policies.
John Maynard Keynes proposed an alternative to holding dollars – something like an anti-Bretton Woods. His aim was to avoid US financial dominance by creating a fiat currency, the bancor. That was not a form of international money, but had a special purpose as an asset of “paper gold,” akin to what the IMF later introduced as Special Drawing Rights (SDRs) in response to the US Government itself needing a bailout as its foreign military spending pushed its balance of payments deeply into deficit during the 1970s war in southeast Asia. Bancors or SDRs could be issued to countries running balance-of-payments deficits to pay payments-surplus countries.
The distinction between a “BRICS currency” and a “BRICS bancor”
This is the problem that the BRICS+ and Global South countries are trying to solve today. The popular press has confused matters by referring to a “BRICS currency.” It is not a currency like the euro or the ruble or renminbi. It is not a currency that anyone could spend at the grocery store or to pay rent. It is not “money” as generally understood. It is not a currency that can be traded on foreign-exchange markets, and certainly cannot be bought by speculators (although they could gamble on what it might exchange for, something like betting on a horse race without having a horse or jockey in the race).
Domestic money, like the dollar or euro, ultimately derives its value from being accepted by national governments in payment of taxes or other transactions with the public sector. That makes such money fungible. Money in that sense can be thought of as a public utility. But providing such currency for a number of countries requires a common government, fiscal authority and legal system. If the currency is to be issued by a number of countries – like the euro – it therefore requires a political union empowered to allocate who gets how much of the currency. No such political foundation yet exists for the BRICS. In President Putin’s words, countries are “at different stages of development.” More to the point, their mutual trade and investment is nowhere near in balance at present. That imbalance is the major problem to be solved, just as it was in 1944-45. It is a balance-of-payments problem, not one of financing domestic government budgets and spending.
How can countries with chronic balance-of-payments deficits (like most Global Majority countries looking to an association with BRICS+) run up debts to payments-surplus countries (like China and Russia), without being forced to impose austerity? How can inter-governmental debt be prevented from causing the problems that the US/Bretton Woods system and IMF “conditionalities” have created?
The first step has been a stop-gap of making swap agreements. That enables countries to settle for trade and investment imbalances among themselves with their own national currencies. The advantage is that there is no need to involve “hard line” creditors such as the United States, and to avoid the risk of US/NATO countries simply grabbing their central-bank monetary reserves as they seized $300 billion from Russia.
But the problem goes beyond simply avoiding the use of dollars and euros. A system of international finance needs to be created that does not impose austerity on debtor countries. That self-defeating policy simply makes it even more impossible to pay the buildup of foreign debts.
Why do governments need international reserves?
Most international payments occur on the “capital account,” for foreign investment, lending, flight capital. But academic textbooks of international trade theory treat it as barter – as if money, currency speculation and flight capital are only a veil. If foreign trade and payments were in balance, there would not be any need for international reserves being accumulated. The books would be cleared. But international payments rarely are balanced.
What is now under discussion is how to denominate the financial claims that result from this imbalance. The buildup of international reserves is not a healthy economic sign if they grow faster than the pace of world trade. When these imbalances – not only of trade, but foreign investment, war-making, currency flight, speculation – rise and accrue interest year after year, they become increasingly unpayable. That is the situation in which the world finds itself today.
The vast majority of today’s central-bank reserves are still foreign holdings of US dollar securities – that is, nominal US debt to foreign governments. The US Treasury did not “borrow” this money. Rather, they spent dollars into the international economy, headed by US military spending in an increasingly aggressive and belligerent way. One could think of foreign dollar reserves as their bearing the costs of US military encirclement of the globe. (This is the process that I have described in Super Imperialism: The Economic Strategy of American Empire.)
Most international payments occur on the “capital account,” for foreign investment, lending and flight capital. If foreign trade and payments were in balance, there would not be any need for international reserves being accumulated. The books would be cleared. But international payments rarely are balanced.
As noted above, the present stop-gap solution is for countries to pay in their own currency, and for payments-surplus nations to accept this. But currency swaps are subject to their own problems. Not only governments exchange their currencies, but speculators not directly involved in exporting and importing. George Soros made his fortune mobilizing lenders to break the bank of England and force it to depreciate by outspending it at the currency poker tables.
The currencies of many countries seem destined to decline – imposing a loss on payments-surplus nations. This has become a problem especially with the euro. At the Valdai meetings, President Putin explained why the euro is unlikely to be one of the currencies into which BRICS+ countries hold as they dedollarize:
Do you understand what happened? The competitiveness of the European economy has fallen, and the competitiveness of their main competitor in terms of the economic component of the United States has increased dramatically, and other countries, including in Asia, have also increased. As a result of the loss of part of their sovereignty, they were forced to make decisions to their own detriment.
Why do we need such a partner? … we are largely moving away from the fading European market and increasing our presence in growing markets in other regions of the world, including Asia.
Among the BRICS+ countries, Argentina is a case in point. Its foreign dollar debt has grown largely by IMF sponsorship. The IMF’s main political function in US foreign policy has been to enable pro-American client oligarchies to move their money out of countries whenever there is a chance of a left-wing or simply democratic reformer being elected. Converting their Argentinean currency into dollars lowers the peso’s exchange rate. Without IMF intervention, that would mean that as the exchange rate falls, the wealthy classes engaging in capital flight receive fewer and fewer dollars.
To support the currency – and hence, the hard-currency dollars that capital-flight actors receive – the IMF lends the right-wing government dollars to buy up the excess pesos that the client oligarchy is selling off. That enables Argentineans to move their money out of the country to obtain a much higher amount of US dollars than they would if the IMF were not lending money to the right-wing puppet government.
When the new reform government comes in, it finds itself loaded down with a huge foreign debt owed to the IMF. This debt has not been taken on in a way that helped Argentina develop its economy and earn dollars to pay back the loan. It is simply a result of IMF support of right-wing governments. And the IMF then tells the new government (whether Argentina or any other debtor) to pay off its foreign loans by lowering the wages of labor. That is the only way that the IMF recognizes for countries to “stabilize” their balance of payments. So the reform government is obliged to behave just like a right-wing government, intensifying the class war of capital against labor. The “cure” for their balance-of-payments deficits thus becomes even worse than the original disease, that is, its rentier oligarchy moving their money out of the country.
Recently, the IMF paid back part of one of these odious IMF loans. It did so with money that it borrowed from China. And China has been in discussions about raising its quota in the IMF to reflect its rising economic power. Yet US politicians have designated China as America’s number-one long-term enemy, and are seeking to expand NATO into the Pacific to ramp up military threats to China. The US/NATO war in Ukraine has been described as a strategy to destroy Russia’s economic ability to support China in the coming Cold War. And to support the West’s arms supply to fight Ukraine, the IMF has lent Ukraine seven times its quota – despite this large a loan being against the IMF rules, despite Ukraine being at war, and despite the fact that this loan obviously cannot be repaid. The Germans have helpfully suggested giving the $300 billion in confiscated Russian reserves to Ukraine to pay its foreign creditors and pay for more US arms.
It therefore seems quite obvious that the IMF cannot play a role in any BRICS bancor arrangement. But it also shows how hard it is to create an alternative economic system to the present legacy of World War II.
The most serious problem has not been discussed publicly. There is no way that a viable and resilient economy for Global South countries and their arrangement for central banks can take shape without repudiating the overhang of US dollar debt. This unpayably high foreign-debt burden is a legacy of US-sponsored financial colonialism. As long as this debt is kept on the books, countries will remain obliged to use their trade surplus and sales proceeds from selling off their property to foreign investors to pay their former colonial powers and post-colonial creditors.
When one talks of dedollarization and the creation of a BRICS+ bank, this is the kind of quandary from which they need to escape. The first need is to create a vehicle to handle the inevitable payments imbalances. At present, these are settled by debt obligations. A key feature of Keynes’s bancor proposal was that if chronic credits accrued to a payments-surplus country – and if their counterpart in chronic debts occurred in deficit countries – these imbalances would be wiped off the books. Keynes’s intention was to prevent debt imbalances from destroying the global economy as they had destroyed European economies in the 1920s.
There is no way that today’s international debt overhand can be repaid. That is as true for the United States as it is for Global South debtors. The US Treasury owes much more to foreign governments in the form of their holdings of US securities than it can foreseeably repay. It has post-industrialized its own economy, and has committed to spending enormous sums abroad, while its dependency on foreign imports is rising and its prospects for collecting its existing debt claims on deficit countries is looking shaky.
The past half-century’s foreign investment has taken the form of privatization of the public domain of debtor countries. This investment has not helped them develop, but has merely transferred ownership of their oil and mineral rights, public utilities and other assets. A viable international financial system requires productive investment such as China’s Belt and Road Initiative that can help countries prosper, not asset stripping.
Perhaps Islamic sharia law has a hint for a solution, in replacing debt obligations with equity arrangements (with buy-back agreements). If the plans being designed by China, Russia and other BRICS members work as intended, countries would be able to pay the investment sponsors out of the growth that would occur – not by imposing austerity as under today’s predatory financial “rules-based order.”
Dollar dominance will continue over Europe and other US satellites. Other countries that still need dollar reserves for their trade and investment with the United States can continue as it has. But what will be changed is a new basis for the international economy itself.
There will not be a new BRICS currency in the sense of a dollar or euro that could become a medium for trade, investment or international speculation. There will only be a mutual “currency of settlement” of payments imbalances among central banks joining the new system. And that system itself will be based on principles opposite from the financialized neoliberal model being promoted by the Dollar/NATO bloc. That is the real context for the current discussion of BRICS+ economic reform.