Hamish McRae: Catching up with the world's newfinancial order

Economic Life: You don't have to have followed the debate about the US budget deficit to be aware that something radical is happening to the status of the dollar
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The Independent Online

So it is now the economic summit of the Brics. If you think about it, it is astounding that the cute acronym created by Goldman Sachs to combine the four largest emerging economies, should have suchglobal resonance that it should be adopted as the title of the new powers' economic summit. Brazil, Russia, India and China are utterly different but the thing they have in common is that they are large and fast-growing economics. This is indeed an idea whose time has come.

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What has given the concept legs right now is that the transition from the old leadership to the new is happening even faster than predicted by the Goldman model. China's economy passed that of Japan last year, and by the end of this year the Brics as a whole will have passed the EU in size. Next year it looks as though they will pass the US. Estimates vary as to when China will become the world's largest economy, with the earliest dates being around 2020 and the latest some time in the 2040s, but if you look at some industries – steel or cement for example – that has already happened.

You can see this in the two graphs. The first is the familiar one showing the world order in 2030, as projected by the Goldman model, showing that by then China will be well clear of the US and India will be No 3. The second graph looks at sales of one particular technology right now, that of mobile phones. As you can see China and India have already passed the US in sales of mobiles, while two of the other top five places are occupied by Russia and Brazil. As far as that technology is concerned the game is over.

This growing authority is reflected in the debate at the Bric summit – to which South Africa has also been invited. That might seem an odd addition, as South Africa's economy remains much smaller than that of many of the other emerging countries. Mexico, Turkey or Indonesia might be better candidates for promotion to the Bric league. But the host of the summit is China its need for Africa's raw materials may have nudged it to inviting a representative of that continent. The summit may be deemed economic but it has a political overlay.

A number of themes emerged in the discussions yesterday: the threat of rising raw material prices to growth in these countries; the social pressures from higher food prices; and the need to reduce reliance on the dollar. This last point is perhaps the one most closely under the Brics' collective control. The others are harder to do anything about. While India and China continue to grow swiftly they will scoop up the world's resources. The emerging world as a whole is at the point of passing the developed world in its consumption of petroleum. If emerging countries had followed different policies they might have produced more of their own food, but as their populations grow they will eat more food. As they grow richer they will almost inevitably want to eat more meat and that puts more pressure on food prices.



But the reliance on the dollar could be changed. It won't happen suddenly and it requires either some new global currency, which would be difficult to establish to say the least, or it requires the merging countries to allow their own currencies to take on a greater global role. both China and India have resisted that. At the moment China is still intervening heavily on the foreign exchanges, piling up dollars and holding down the value of the yuan. It is doing that despite having had a quarter when the trade account was in deficit. India does not want to make the rupee fully convertible. So for the time being at least the dollar remains the principal reserve currency, with a lesser role for the euro and still smaller roles for sterling and the yen. It will all shift, but these things take time.

The most interesting thing, perhaps, is the change of mood at the moment. That is a function not of what is happening in China but what is happening in the US. You don't have to have followed the Byzantine debate about the US budget deficit to be aware that something radical is happening to the status of the dollar and of US government assets. One obvious example is that the dollar is slipping on the exchanges; another that gold is at new highs; still another that commodity prices, in dollar terms, have been soaring. What I find more impressive, you might even say chilling, is the way in which the possibility of a US default is being openly debated.

Bill Gross of Pimco, the world's largest bond fund, has gone public on warning of some kind of default – not an explicit one, but an implicit default – and sold all holdings of US government debt. Now I see some notes from Bob Janjuah at Nomura on how the US was pushing its credibility by asking, one, investors to lever up at the wrong price; two, to take on risk at the wrong price; and three, to do so at precisely the wrong point in the business cycle. He thinks the Fed will continue pumping up the economy with further quantitative easing and he warns: "We fear [for] the credibility and status of the US, the US dollar and US Treasuries."

"The result," he concludes, "most likely at some point between 2012 and 2014, will be major foreign exchange regime changes and significant paradigm shifts in global foreign exchange markets."

It is worth quoting these views because though they are widely reflected in conversation among investors they are not yet reflected in market rates. Yes, the dollar is weak but not that weak. The US is still able to borrow very cheaply.

Now, that may be because the US Fed is printing the money to enable it to do so and because the Chinese are still piling in and buying the stuff. But the fact remains that US Treasuries are regarded as safe havens for cash, despite the dreadful maths of the US deficit and the political difficulty the US system has in coping with that. The headlines over the past few days have been that there are to be giant budget cuts. In reality, if you look at the assumptions behind the projections for both revenue and outlays, the deficits go on and on.

Markets are very bad at assessing risk. Just yesterday there was a new wave of selling of Greek and Portuguese debt, with the rates on Greek debt now suggesting that it was an odds-on wager that it would default, paying perhaps only 50 cents in the euro, within the next five years. But three years ago Greece could borrow at only a couple of percentage points more than Germany. The money managers were talking of "convergence" of eurozone rates and urging investors to buy.

There is a different sort of convergence happening. It is between the words at the Brics summit and the words of dissident fund managers and advisers. Both agree that the financial order does not reflect the economic order. The economic order is not going to change: the shift of power runs on. So the financial order will have to change. Simple as that.

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