China and Brazil to Ditch U.S. Dollar? Hardly

Brazil's state visit to China has set the chins wagging. Will an agreement be struck to invoice their bilateral trade in their own currencies rather than the dollar ? Brazilian President Lula had made some allusions to this last month around the G20 meeting.

In a note Monday, we tried to highlight the distinction between declaratory policy--in terms of investment agreements between China and Brazil--and operational policy--what is really done. Today Brazil and China reached 13 new agreements, including China's Development Bank,and signed a $10 bln credit agreement with Petrobras and $800 mln credit line for the Brazilian government's development bank. This is very much as expected.

Contrary to speculation that circulated, there was no agreement on the invoicing currency for bilateral trade. In March and April, China and Brazil's bilateral trade surpassed Brazil-US bilateral trade. Although this likely more a function of the deep contraction in the US than a surge in China-Brazil trade, it may be adding fuel to such talk.

No doubt the two countries would like to settle trade flows in their own currencies, so when Brazil buys goods from China it pays in reals and when China buys goods from Brazil it would pay in yuan. But neither country is really prepared for this. That is why Brazilian officials quoted by the news wires say something innocuous, like "it is something we will work towards". This is hardly news. China is working toward making its currency convertible, but it is not there yet. There are several considerations that go into making a currency an attractive invoicing unit, and official desires do not rank that high. Even for the euro zone, not much more than half their exports are invoiced in euros.

Using the BRL or CNY as an invoicing currency instead of the dollar would pose new risks to businesses in both countries that officials, pursuing status, may not fully appreciate. Those currencies are not nearly as liquid as the dollar. The Chinese currency is not really traded outside of China and the Brazil real has liquidity to speak of only a few hours a day and none while Chinese markets are open.

Separately, though related, China's economy does not simply complement other developing economies, but it also competes with them. Lula, who is not known for his nuanced thinking, has embraced the BRICs as some kind of singularity and not a clever marketing device. The raw materials that China is so hungry for will be used to boost China's productive capacity and manufacture goods that will then compete with other developing economies, like Brazil. That kind of trade may help underpin exports, but it does not lead to development in the same way that the US direct investment strategy--building plant and production locally--frequently does.

Comments

[Dave Wrixon:]

You can kick this around as much as you like, but the only reason that the dollar is still worth anything is that a lot of governments are reluctant to see their US investments written down. However, at some pont in time they will bite the bullet because the truth is that they stand to gain more than they would lose.

May 20 04:47 AM

[AJB7:]

I suppose it's a technical note, but the Chinese currency is the renminbi and not the "yuan", which is actually the unit of currency of the renminbi. To the Chinese this is like calling the US currency the dime or penny. Still, saying renminbi all the time is a bit of a tongue twister I'll admit, and since we're Americans let's just call it what we want!

May 20 06:31 AM

[User 353732:]

Brazil is likely to emerge as a significant oil exporter within a decade. Brazil's very large new offshore oil reserves are, potentially, a major source of future national wealth and income, if it does not squander the opportunity. Brazil is keen to develop these resources rapidly but in a way that allows it to maintain control and also advance its deepwater oil and gas development technolgies and capabilities thru Petrobras, which is perhaps the most competent oil mini-major not domiciled in the West.
I think Brazil wants to turn Petrobras into a true global oil and gas company that can compete with the Western majors and mini majors as well as with state owned oil companies for opportunities in Asia, Africa and other parts of Latin America. Petrobras has emerged as a skilled driller and operator in deepwater Gulf of Mexico. Brazil has attained a global staure in the iron ore industry. It aspires to replicate at least part of this success in the much larger global oil and gas industry and hopes to become the foreign oil company "of choice" in many parts of the Global South.
In this regard Brazil and China are not competitors but trading and business partners. I do not see Brazil trying to bypass the dollar in cooperating with China but to attain its broader, national, strategic goals.

May 20 06:53 AM

[Bull Run:]

Chinese "baby steps" towards allowing it's currency to float or trade in capital accounts seem to be taking forever, but if forever comes the US doolar will suffer a diminsihed role, therefore a diminshed value in foreign eschange. China has been quite aggresive in it's currency swap approach to sidestepping the issue of floating the Yuan. Argentina was the last, and it has dramatic effects. Prior to a currecny swap Argentina would have to use it's US dollar reserves or sell gold to buy US dollars to pay it's Chinese trade accounts.. This is NO longer needed, with the Yuan begin directly used to pay Argentina's trade accounts. Now Argentina's US dollar reserves can be used for other accounts, currency support, or international commodity purchases. The bottom line is, that less US dollars are used,( and US treasuries for short term storage) and less are needed, which continues to push down the dollars value.

May 20 09:19 AM

[Albert Meyer:]

Today's Financial Times (News Briefings), on the front page, reports on China's $10 billion loan to Petrobas, in exchange for guaranteed oil supplies. The next items tells of the neocons in Washington dumping another $110 million into a black hole called the Swat Valley in Pakistan. While China uses its own capital to take care of its commercial interests and to strengthen its foreign trade relations, the US continues to pile up the national debt to prop up its foreign empire that isn't worth squat.

On another point, Marc Chandler's letters to the Financial Times are required reading for their insight. Keep them coming, Mr. Chandler.

May 20 09:40 AM

[jayminho:]

50/50 mr. poster

May 20 09:56 AM

[discov:]

tinyurl.com/p5umqc chart of UUP is helping me figure out when to expect major loss of value in the US dollar. The December lows are very important.

May 20 11:15 AM

[Fighting Yoda:]

The arrangement China and Brazil are seeking is to use Yuan for trade based on Yuans supplied by China for currency swaps - so the invoicing occurs in Yuans (not Reals). This is plausible arrangement - Chinese currency is strong and stable - huge currency reserves and trade surplus to back it. Every small trade does not have to be done in Yuans - the major trades (likely accounting for 95% of the trades) can be done in Yuans - deficits can be suitably settled every few years.

This is beneficial arrangement for the two - I can see them implementing it.

May 20 08:22 PM

[Thomas Wagner:]

Im somewhat puzzled by the author's assertion that China and Brazil are far away from settleing there current account transactions in BRL/RMB. In fact they already are. When Brazil purchases goods from China it pays for them in BRL and the sellor of the good is allowed to hold BRL or convert them to RMB throught Chin's SAFE. SAFE either sells it on the open market or increases Chin'a foreign reserve account. Most transactions are mearly invoiced in dollars as a matter of convenience, but they are not necessary settled using dollars as a cross currency. So the fact that they may or may not invoice in dollars is really irrelevant. I seriously doubt any BRIC company settles transactions by first converting to dollars then to the payee's currency. The simple fact is that as trade increases by and between BRIC countries and decreases between the US and BRIC countries the importance of dollars is deminished. More importantly the necessity of holding dollars and dollar denominated assets is deminished. Something Ive discussed in my recent articles.

May 20 08:58 PM

[Bull Run:]

A futher comment on nations paying their trade accounts in US dollars; This is the usual method,though that may change as circumstance dictates. ex. Russia sells energy to China so it is able to make demands in trade with China, these demands are to pay its trade accounts in it's own crrency. The problem with al lot of currencies is they are very thinly traded and have questionable value, outside of that country. The result is many large exporting nations require US dollars to pay their trade accounts, even though the goods are valued in the whatever. eg. Korea demands payment from Canada in US dollars for its exports, and Canada is a G7 member, but Canada doesn't care because it runs huge US dollar surpluses with US trade, (trade balances), and can use these US dollars to pay it's foreign accounts. Canada is also very reluctant to hold any US dollar, either currency or treasuries, so using them in trade accounts is good. Brazils currency is another story. In the past Brazil has run 3 and even 4 currencies at the same time, including the US dollar. As each older currency faded in value they would issue a new one, which in turn would inflate to Zero.Each trade or account is different, but many just use the US dollar.

May 21 09:55 AM

[cameroni:]

You are right Marc.

The world needs a reserve currency. One that is widely accepted, portable and backed by a major economy. In fact, with the Chinese and Japanese holding so many dollars they are in effect also backing the the US currency. It is in their interest to support and maintain it's acceptance and convertability.

Exercises with Renminbi and Real are not a threat to US dollar dominance and all parties know that. To possess, control and manage a truly global currency you also need to be a truly global player. China is still too insular politically and will need decades more practice and a change in how it governs itself before it has the kind of influence and respect needed to pull off reserve currency status. So yes, I agree with your contention that neither China nor Brazil have any real plan to ditch the US dollar.

They (the Chinese) are merely positioning and waiting for a moment of global economic weakness to push the "currency basket" agenda and in effect cut their vulnerability to the US dollars.

Cam

May 26 05:20 AM