Brazilian President Lula is the latest world leader (after Wen Jiabao and Vladimir Putin) to call for moving away from the US dollar in trade and and for a new monetary and financial order. On the eve of his trip to China this week, Lula suggested in an interview with Caijing (and other news sources) that the two countries should conduct more of their trade in their own currencies rather than the US dollar.
“Between Brazil and China, we need to establish a trade that is paid for in our own currencies. We don’t need dollars. Why do two important countries like China and Brazil have to use the dollar as a reference, instead of our own currencies? We’ve already started doing this with Argentina. Our trade is taking place in our own currencies. Otherwise, we’ll be in an absurd situation, where the country that caused this crisis will be the country that gets the most dollars. It’s crazy that the dollar is the reference, and that you give a single country the power to print that currency. We need to give greater value to the Chinese and Brazilian currencies.”
Early this year, China supplanted the U.S. to become Brazil’s largest trading partner, as its commodity demands resumed and Brazil’s trade with the U.S. slumped. At the moment, Brazil is one of the few countries with which China runs a significant deficit which rose to $11 billion for all of 2008. Chinese imports are almost all raw materials.
Greater use of the RMB in trade with Brazil would be yet another step China has recently taken to increase the use of the RMB outside of China. China has been signing 3-yr RMB/local currency swaps with a range of emerging and frontier markets including Argentina, Brazil’s neighbor. As Nouriel Roubini notes in a recent oped, these swaps are small steps towards a possible greater international role of the RMB – pilot projects to use RMB as a settlement currency in Hong Kong Macau and Asean are other such steps. These deals are also another way to provide a bit of trade finance to key trading partners. The swap with Argentina might help finance China’s extensive trade with the country. As a result, even if US dollars are not used, it could well be the RMB and not the BRL that is used, especially if China wanted to avoid bearing the exchange rate risk.
In addition to the Petrobras-CDB deal the Brazilian development bank BNDES is reportedly seeking a credit line from China. BNDES, like other trade credit providers globally, has taken on a higher profile in the face of the withdrawal of private trade finance. Such a loan could be conducted in RMB/BRL. While that would be major, there are significant preconditions before the RMB internationalization progresses further. In particular, the more the RMB is used outside of China’s border the less control the central bank has. In this way China’s shorter-term goals of economic stabilization and longer term goal of more sustainable consumption driven growth may conflict.
While using their domestic currencies in bilateral trade would be significant, and could affect demand for US dollar assets, the currency is used as a store of value by Brazil and China is even more important. That is, how these countries manage their savings or if they (especially China) begin consuming more and saving less abroad, will have a greater impact on foreign exchange markets. The increased use of currencies as a unit of account, can over time increase demand for a currency as a store of value, but that is not always the case.(Note: This same dynamic holds for OPEC and other oil exporting countries who every so often start talking about pricing oil in another currency. It is the asset allocation of oil exporters savings that affects asset markets not the currency in which their exports are prices). China clearly wants to start diversifying its savings, especially on a going forward basis but at the moment, it seems loath to switch away from US dollars. The most recent data from the US treasury (March) shows that China has continued to add to its US government bond and bill holdings in Q1 adding $15b of US long-term treasuries in March 2009 and a total of $34 bn in long-and short-term US claims. T-bill holdings have particularly increased As Brad Setser notes, close scrutiny of the flow of funds shows that the growth of central banks (including China) holdings of the safest US assets has outstripped that of foreign exchange reserves.
Much of the same story can be told about Japan… despite recent opposition threats to dump the dollar, at least as recently as March, Japan was still buying treasuries (a net $23 billon of them in fact). So at least so far the scary scenario depicted by Ambrose Evans-Pritchard in the Telegraph is not yet coming to pass.
In China’s case the increased demand for T-bills in recent months likely reflects a decision to swap between different US assets, shifting both from agencies to treasury bonds but also from money market funds to even safer assets. Switching to more liquid assets could be the first step before investing in more real assets but it is also a reflection of the fact that China is still buying U.S. government bonds. Brazil is a bit of a different story. It has been reducing its holdings of US assets both Long-term and short-term treasuries. However on the margins, even China is diversifying its assets, increasing its holding of gold from a low base. It has also extended loans worth over $50b to resource rich but cash poor companies, especially national oil companies like Petrobras, in one of several deals that should be signed on Lula’s Chinese jaunt. While the details are not firmed up, the loan is expected to be for about $10 billion, with the China development bank contributing to Brazil’s war chest to further exploit the recent finds in the deepwater pre-salt layer. As with deals with Kazakhstan, Russia and Venezuela, along with the loan comes a more extensive oil supply contract. Such deals not only seem to be part of the general Chinese government support of commodity purchases (through foreign acquisitions, building up of domestic reserves) but also more strategic investments by Chinese oil companies which had been split between acquisitions in many countries.
As far as can be told, this deal may be in dollars not in RMB and could be part of deeper cooperation between Petrobras and Chinese oil companies. Petrobras is also angling for some contracts and joint ventures in Chinese offshore waters, perhaps hoping to use its newfound expertise in such areas.
China and Brazil have common interest in seeking changes in the institutions of global economic governance. Both have sought an increasing role at the IMF and other institutions. It was the Brazilian finance minister that called most strongly publicly for emerging economies to be integrated into the financial stability forum (FSF) a process that is ongoing. Both are key members of the G20 which is now the key institution for responding to the financial crisis.
They may also both purchase a significant amount of any new SDR bonds issued by the IMF. As Eswar Prasad notes, buying SDR bonds seems like a go
od calculus for Emerging economies as it allows them to diversify their reserves slightly (given the SDR’s lower dollar share) and allows them to provide short-term (12-18 months) of funding to the IMF – enough to help the institution’s cash flow needs, but short enough to wield leverage on governance discussions.
The countries are also increasingly cooperating on security issues from military supplies and especially a joint satellite program. How this will be used is uncertain but it is a sign of the deeper ties that may evolve over the next few years and decades and could provide a challenge to the U.S.
But there are some lingering issues between China and Brazil. Thorny issues may include the ongoing price negotiation for 2010 iron ore between China and the Brazilian company Vale. In the last year, positions have shifted and consumers like China have shifted from being price takers to price setters. Despite the partial revival in commodity imports and reduction in shipping costs from 2008 highs, iron ore demand and prices remain under pressure. The Chinese fiscal stimulus will provide some support, but perhaps not as much as the big iron producers hope.
The bulk of China’s imports from Brazil are raw materials, especially iron ore and soya. In the longer term there are several questions about the complementarity of trade between China and Brazil, the majority of trade and even more of the increase in trade has been in raw materials, both metals and agricultural ones. Shifting too much production to meet Chinese material needs could lead, as Wickenbockel argues, to a slight Dutch disease effect as other sectors are crowded out. Moreover, as China moves up the value chain especially with respect to technology exports, it may be increasing compete with Brazil. Given that China has set developing aircraft as a key economic development goal, it may only be interested in so much cooperation with a Brazilian company like Embraer.
Perhaps the biggest issue pervading Lula’s trip is whether China will invest more in Brazil. As Andre Soliani of Bloomberg notes yesterday, only about 2% of the Chinese investment promised on Hu Jintao’s 2004 trip to Brazil has been made. And Lula noted also that there are more Brazilian JVs in China than the reverse. Despite the existing joint ventures, it is uncertain if China will allow much investment by foreign countries, if that means a stronger RMB in the short-term when trade continues to be weak. Brazil might not appreciate a stronger real. However, in the longer term, a more significant role in the global economy will likely mean stronger currencies of such key emerging market economies. But these are not changes which would happen over night. Related RGE Content
Note: Thanks to Adam Wolfe for sourcing the data and to Italo Lombardi for insights on Brazil!