This week as part of the ongoing sovereign debt crisis affecting the Euro we were treated to a suggestion by Brazil’s finance minister, Guido Mantega, that as part of their meeting on September 22nd in Washington, the senior officials from the BRICS (Brazil, Russia, India, China, and South Africa) should hammer out a possible rescue plan for Europe.
Brazil’s President Dilma Rousseff seconded the suggestion and encouraged the proposals for an “international effort” to help rescue Europe from its debt crisis. Pundits loved the idea as evidence of a major shift in the balance of the global economy toward emerging markets.
There is no question that the global economy has shifted in favor of emerging markets. The combined output of the developing economies is now 38% of world GDP, double what it was twenty years ago. Their exports have also almost doubled in the same time period and make up a little more than half of the world’s exports and 47% of its imports. This growth is certainly gratifying, but to assume that there is such a thing as an economic bloc of BRICS or that it should be loaning money to help out Europe is simply absurd.
Brazil, India, Russia and China certainly have the money to make a difference. Their foreign reserves are about $300 billion for India, $350 for Brazil, almost half a trillion dollars for Russia and over three trillion for China. All of this cash needs to go somewhere. In the past it was usually invested in United States Treasuries, but with the ultra low interest rates and the depreciation of the dollar that no longer looks like a good bet. No doubt there have been attempts to diversify.
Increasing gold reserves has been popular recently. But with gold at a historic high, this might be a better time to sell rather than buy. The politicians who run these funds don’t quite see it that way. They are again putting their money into an asset that rises for no other reason than people think it will rise.
Then there is the irony of some rather poor countries bailing out some of the richest. On a per capita GDP basis Greece, one of the poorest of the Eurozone members, ranks 28th in the world. The highest ranking BRIC is Russia who comes in at number 50. Brazil is about average at 75. China and India are in the bottom half at 95 and 130 respectively. Greece’s average income at $28,000 is a little less than twice Russia’s, almost three times Brazil’s, four times China’s and eight times India’s.
Then there is the question as to why these reserves are so large. Large reserves of foreign currency allow a government to stabilize foreign exchange rates and put it in a better position to defend itself from speculative attacks on the domestic currency. But there can be large costs. China has maintained huge dollar reserves and its losses have been proportional as the dollar has declined.
China’s reserves are not necessarily the result of a foresighted economic policy designed to create sustainable growth. On the contrary, it is part of a policy of investment-led growth stimulated by artificially cheap financing and currency manipulation. The result of this intervention into the market is a massive misallocation of capital that could very well result in a long post boom period of stagnation.
Besides China has no reason to invest in the Euro. They are simply a bad investment. The yield is next to nothing and they might default. China has been investing in Euro bonds, but prudently only buys German bunds.
Russia too has demurred. It correctly points out that the Europeans really have not yet produced a clear strategy. These doubts did not stop Russia from negotiating a $3.4 billion dollar bailout for EU member state Cyprus. Cyprus has a banking sector that is seven times larger than its GDP and much of that is Russian money of dubious origin. Since Cyprus is Greek, its banks are among the highest holders of Greek sovereign bonds in Europe. So Russia was just looking out for its own.
So what are these loans really about? The Nobel laureate Paul Krugman in his book “Pop Internationalism” explains that firms compete, countries do not. Companies from America and China compete for customers, but if the Chinese firms do better it does not necessarily follow that China is winning. What countries or at least their politicians compete for is something else: status and power. The problem is that status and power may not have any economic value. The US has discovered if not learned that the pursuit of status and power can be exceptionally wasteful and expensive. Perhaps Brazil will make a similar discovery if it is foolish enough proceed.
