In These New Times

A new paradigm for a post-imperial world

BRIC group plans own revolution

Posted by seumasach on June 16, 2009

W.Joseph Stroupe

Asia Times

17th June, 2009

Russia announced on June 10 that it will purchase US$10 billion of the new SDR-denominated International Monetary Fund bonds. It also announced that it will further diversify its $140 billion of US dollar holdings. Brazil will also buy $10 billion worth of the new bonds, and China will buy $50 billion of the new bonds. India will likely announce its own purchases very soon.

These are merely the opening moves by the BRIC (Brazil, Russia, India, China) countries, leaders of the emerging market economies of the world. Their summit on Tuesday in the central Russian city of Yekaterinburg, scene of the July 1918 execution of Tsar Nicholas II and his family, may prove to be a milestone in efforts to engineer the architecture of a new global order spanning financial, economic, trade, and monetary matters.

The new IMF bonds are denominated in the synthetic Special Drawing Rights (SDR) currency, which represents a basket of currencies. In effect, the purchaser enjoys enhanced insulation from currency risks associated with the US dollar. In addition, the purchaser spends US dollars to buy the new bonds, thus furthering his goal of divesting of dollars. There are also political motivations for the announced purchases – no doubt the BRIC countries are seeking to drive home to global investors the fact that the emerging economies are fundamentally healthy, able to provide funding in the midst of this terrible global crisis for aid to economies in the emerging markets that are struggling, and thus they (BRIC) are an attractive place for continued investment flows.
Also, BRIC members are making a potent bid for a much greater voice in international organizations and institutions such as the IMF, the World Bank and so forth. The old status quo where the US and Europe dominated the global order and its key institutions is rapidly changing as the emerging economies take up key positions in the global economy, international finance and trade.

BRIC members are ensuring that their leverage against the US and Europe is enhanced within such institutions just when deliberations over how to transform the present order begin to heat up. This is a pragmatic and forward-looking move on their part. As the primary global lenders, they see a real opportunity to leverage their strengths against US and European weaknesses to achieve key concessions that have to do with moving the present global order along the path of transformation to something new.

The present US administration may well be unwilling and unable to risk alienating and angering BRIC members as deliberations proceed, for fear of losing crucial lending. Such negotiations and deliberations are going to be very tough for the US side. Thus, BRIC is rapidly moving into a strong negotiating position with respect to the US and Europe, and its members cleverly seek to consolidate

their positions in key institutions and organizations.

Whether SDR-denominated bonds ever takes the place of the US dollar as the international reserve currency is a matter for the future. Such a replacement for the dollar is only one proposal of several on the table in international deliberations over what a new order should look like. But these new bonds don’t have to become an international replacement for the dollar in order to serve a key purpose, that of helping to facilitate the increasingly resolute policies of central banks to employ multiple mechanisms to decrease their exposure to the US dollar, sooner rather than later, but doing so in an orderly fashion without risking a dollar panic.

Converting dollars into hard assets
China’s compelling new policy of converting ever-greater sums of dollars into hard assets is now accelerating as it stockpiles an ever wider array of resources and commodities and buys up equities in resources-oriented companies around the globe. The recent defeat suffered by Chinalco in attempting to acquire stakes in Rio Tinto is not deterring China from continuing to pursue a raft of smaller, lower-profile but key outbound acquisitions around the globe.

China’s stockpiling of resources, its loans to resources-based companies, its outbound acquisitions and its funding of crucial energy projects and pipelines all afford it and its partners multiple important advantages presently and going forward.

China’s trade ties and trade volumes with the resources-oriented under-developed economies of the world are being widened, deepened and boosted. China-Brazil trade is but one key example. China has now eclipsed the US as Brazil’s biggest trade partner.

Deeply important political/geopolitical advantages accrue to China (and generally to the emerging market nations as a whole) from the bolstering of trade ties noted above. These political/geopolitical advantages reinforce China’s growing global leverage against the developed West in many key spheres by helping to advance the political and economic consolidation of the under-developed, resources-oriented nations more in line with China’s position and its world view.

Especially is that so when one considers the fact that China, in the gross absence of leadership by the developed economies as the traditional drivers of global demand and growth, is emerging as a key financial/economic driver for a return to global economic growth, as the IMF is now predicting. Against the backdrop of the intensifying international debate and deliberations over how to reform and transform the old US-centric global order, these growing political/geopolitical advantages do indeed enhance China’s position and leverage and those of its partners.

China and the under-developed, resources-oriented economies are consolidating their control of strategic resources of all kinds during this crisis. As global growth returns, their collective leverage over production and pricing will only turn out to be greatly enhanced, as will their geopolitical clout as a direct result. This, of course, bodes ill for the developed economies of the world as respects their once-dominant global leverage, since they are profoundly dependent upon imports of all such resources from the under-developed nations of the world.

China’s central bank enjoys the advantage of steadily decreasing its exposure to the dollar as it accelerates its conversion of dollars into hard assets. China also reduces its reliance upon the dollar in trade to the extent that its bilateral trade with its partners comes to be conducted in currencies other than the dollar and to the extent that its loans to its trade partners become denominated in something other than dollars. As these mechanisms come to be employed to a greater extent then China’s forex reserves will naturally take on a much more diversified complexion, reducing the role of the dollar component.

China’s accelerating policy of converting dollars into hard assets plays into its larger strategy of decoupling in a very potent way. The decoupling strategy is dealt with in detail later in this article.

In view of the foregoing, no objective observer can any longer conclude that China’s leaders or those of its partner nations are “all talk”. No indeed, for they are prudently and intelligently beginning to put their money where their mouth is.

Panda bonds
One of the most interesting proposals put forward on the subject of paving the way for greater use of other (non-dollar) currencies in international finance is that of issuing so-called panda bonds. On a June 7 visit to the US, Guo Shuqing, the chairman of state-owned China Construction Bank (CCB) and former head of the State Administration of Foreign Exchange suggested that the US government and the World Bank consider the possibility of issuing renminbi (also referred to as yuan) bonds in the Hong Kong market and the Shanghai market.

The bond issues could be relatively small to begin with – perhaps 1 billion to 3 billion yuan (US$142 million – $436 million). Exactly what is a panda bond and how would they work? What would be the advantages and disadvantages? How might such a mechanism affect the dollar and US Treasuries?

Fundamentally, an issuer of any bond does so in the interest of borrowing money from global lenders, whether such lenders may be individual investors, bond or other fund entities, central banks or perhaps a combination of some/all of the above. Bonds are denominated in a particular currency. That means they are purchased in that currency and they are redeemed in that same currency.

For example, US Treasuries are denominated in dollars, and when the purchaser redeems or sells the bond he receives dollars in return. A panda bond would be denominated in the Chinese currency

, the yuan. That means any purchaser would pay yuan to own the bond and he would receive yuan when he redeemed or sold the bond. Remarkably, however, the issuer of a panda bond would not be any Chinese entity (central bank, state bank, company and so forth) under this relatively new proposal. Instead, the issuer would be the IMF, the US Treasury and/or US corporations. Potentially, issuers could include other non-Chineseentities as well. At this point, let’s step back a bit of a distance and analyze what this proposal really means.

Since any bond issuer is a borrower from international lenders, what we’re saying here is that the IMF, the US Treasury and/or US corporations would be issuing panda bonds for the purpose of borrowing in foreign currencies, in this case specifically the yuan. Why would these issuers even consider such a possibility? In fact, it has been done before in the recent past.

You may have heard of the term “Carter bonds”. In the 1970s, the dollar was declining so rapidly that foreign lenders became afraid the US Treasury would repay its debts in much weaker dollars, so they soured on buying US sovereign debt. In order to defend US finances, president Jimmy Carter directed the US Treasury to issue billions of dollars of US Treasuries denominated in German marks and Swiss francs so as to attract foreign investors into Treasuries.

Fundamentally, then, issuers like the US Treasury prefer not to issue bonds denominated in foreign currencies but may be forced to consider doing so when the dollar (or the currency of another issuing government) declines too far too fast and foreign lenders become concerned that the issuer is attempting to inflate away its debt. In such situations, regarding the US, foreign demand for the dollar and for Treasuries sinks, forcing the US Treasury’s hand. In fact, we are now nibbling on the edges of just such a perilous situation for the dollar and for Treasuries as yields escalate and foreign demand is undermined.

How does a panda bond work? The issuer (the IMF, the US Treasury or a US corporation) issues the bond denominated in yuan and sells it on the international bond markets. The buyer (a private or official Chinese or other investor) pays yuan to own the bond. The issuer doesn’t want yuan, but does want dollars. Therefore, he goes to the international currency markets and exchanges (sells) his yuan for US dollars.

Now he’s happy because he has succeeded in borrowing dollars, his original intent in issuing the panda bond in the first place. The owner of the panda bond is happy because he holds a financial asset that isn’t denominated in the ever-more worrisome US dollar. When the owner wishes to redeem his panda bond, the issuer uses dollars to buy yuan on the international currency markets and pays the owner yuan to redeem the bond.

You can begin to see that to the extent the issuers of panda bonds increase the supply of such bonds, then they bear the currency risks associated with the dollar, relieving the rest of the world of such risks. Thus, panda bonds are an effective way of focusing dollar currency risks back onto the US.

Very importantly, they are also an effective way for China’s central bank to decrease its exposure to the dollar. How so? When the issuer (the IMF, the US Treasury, a US corporation) of a panda bond receives yuan at the point of sale of the bond, he must then buy dollars on the international currency markets.

China’s central bank enters the picture here – it can provide the dollars sought from its excess of dollars held in its forex reserves. Therefore, from the perspective of China’s central bank, it is selling dollars for yuan, thus decreasing the dollar portion of its massive reserves, and all the while the issuer (the IMF, the US Treasury, or whoever) bears the full currency risk associated with the dollar. In effect, China’s central bank is lending its undesirable excess of dollars to foreign borrowers. But here’s the best part from the perspective of China’s central bank – when the loans are repaid with interest, they are repaid in yuan, not dollars. So it becomes a win-win situation for China’s central bank.

There are obstacles. One is that the yuan is not yet convertible; another is the traditional desire of the Chinese to control bond issuance. But these obstacles are by no means insurmountable. In fact, both the Asian Development Bank and the World Bank’s International Finance Center issued panda bonds in October 2005 as part of attempts to deepen China’s domestic bond market.

Additionally, China’s leaders are taking meaningful steps to increase the international role of the yuan. And in late May this year, China has paved the way for international companies to issue securities in its currency for the first time, telling two foreign commercial banks they have its backing to sell yuan-denominated bonds to overseas investors. The China units of London-based HSBC Holdings and Hong Kong’s Bank of East Asia each confirmed an official notice that they have been granted permission by authorities in China to launch international bonds denominated in yuan. The banks plan to issue the debt in Hong Kong to fund their China-incorporated banking networks, which are the two largest among foreign banks operating in the world’s most populous nation.

Historically, China uses Hong Kong as a trial point for new financial instruments. So this new development strongly suggests that China’s leaders are very serious about instituting this mechanism sooner rather than later.

The reader should be careful not to push such a development far off in his own mind, for, against the backdrop of rapidly increasing worries about the dollar, international pressure is building fast upon the IMF and the US Treasury to issue panda-type bonds – bonds denominated in foreign currencies. For example, late last year, a number of top Japanese economists called for the US Treasury to issue Treasuries denominated in yen. Japanese officials are increasingly worried that Japan’s huge holdings of Treasuries are at risk from a declining dollar.

The fact is that a situation is rapidly developing where foreign demand for Treasuries is coming under rapidly increasing pressure – remember the strategic shift to the short end in the patterns of lending by foreign investors that is detailed in Part I of this series.

The tipping point is rapidly approaching where foreign lenders will be unable to justify deepening their exposure to the dollar. In a sense, this becomes a game of chicken between the lenders and the borrowers to see who blinks first. The lenders, already massively exposed to the dollar, most certainly are not the ones that will blink first. The borrowers (primarily the US Treasury), increasingly at risk of a full-blown implosion of their finances, will be the ones to blink first by agreeing to issue panda-type bonds. This development could be mere months away.

When it does unfold and builds sufficiently, then it is possible to envision within the next very few years the development of a bond market centered in Asia to rival the depth and liquidity of the present Treasury market. Especially is that foreseeable if the dollar’s troubles continue to mount. Increasing numbers of global investors will want to hedge against dollar losses and they will see an alternative bond market as more and more appealing.

If China and its emerging market partners do emerge from this crisis as the new collective driver of global demand and growth, as now predicted by a number of expert sources and institutions, then such an Asian bond market will be part and parcel of such a global role.

Next: Decoupling from the US

W Joseph Stroupe is a strategic forecasting expert and editor of Global Events Magazine online at

(Copyright 2009 Global Events Magazine, All Rights Reserved)

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