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BRICS Currency Crisis

Written By Briton Ryle

Posted September 9, 2013

While the U.S. Federal Reserve pumped cash into the American economy through three rounds of stimulus, the USD remained constrained, while foreign currencies enjoyed remarkable rises in appreciation. Not anymore.

bricsSince Fed Chairman Bernanke’s May 1st announcement of upcoming reductions to one of those stimuli – the $85 billion monthly bond purchases – emerging market currencies have been tumbling.

Russia’s ruble has lost 7.7% of its value versus the USD, South Africa’s rand lost 12.5%, Brazil’s real lost 15.2%, and India’s rupee has lost a whopping 21.5%. China’s yuan, however, has actually gained 0.75% due to the Chinese government’s unofficial and publicly-denied fixing measures tying its money to the USD.

These five nations in particular – already sharing an allegiance as the BRICS group of nations – are now attempting to pool their resources together, creating a $100 billion emergency fund.

But can yet another fund for emergency loans really be the answer? Or might it be time for a new global reserve currency that is not tied to the economy of any one single nation?

The BRICS’ Solution

The second most debated issue at the G20 summit in St. Petersburg, Russia over the weekend was the weakening of emerging market currencies, which has eroded buying power, widened budget deficits, and begun stoking inflation, which in turn consumes wealth. Concerns were raised at the summit that even more damage would be dealt to emerging markets if U.S. stimulus were reduced too quickly.

“They emphasised that the eventual normalisation of [U.S.] monetary policies need to be effectively and carefully calibrated and clearly communicated,” the Indian delegation noted in a statement obtained by the Indian paper Hindustan Times.

If the U.S. Fed reduces its monthly bond purchases too quickly, emerging economies would not have sufficient time to close the gaping holes in their budgets as their money erodes.

“We see the temporary difficulties … in terms of international balance of payments,” addressed Chinese Vice Finance Minister Zhu Guangyao at a press conference, as transcribed by Reuters. “The policy options in response to such … difficulties include increasing interest rates or devaluing currencies.”

In line with that standard practice, Turkey has already raised interest rates by more than 2% in the past two months, with numerous other emerging nations following suit. But not all nations are prepared to hike interest rates, which slows economic growth by costing business and industry considerably more in operating costs and debt financing.

Hence, the leaders of the five BRICS nations announced their plan for a $100 billion fund from which each of its members can draw emergency relief when required. China, for its part, will be contributing the largest amount at $41 billion, where Brazil, India, and Russia will put in $18 billion each, while South Africa adds $5 billion.

In addition to this Contingency Reserve Arrangement (CRA), the five partners are also founding the New Development Bank (NDB) with $50 billion in capital, providing emergency loans to member nations much like the International Monetary Fund, though without its stiff political conditions and penalties.

“In the list of the progress achieved in the negotiations of the NDB and the CRA, the BRICS leaders expect tangible results by the time of the next Summit,” Hindustan Times cites the press release.

The Global Currency Solution

Yet many have questioned the practice of using a single nation’s money as a reserve currency in the first place. They question the soundness of resting the stability of the entire world’s money supply on the back of one single economy. The events of the past five years since the financial crisis have proven the point.

From the spring of 2009 to the summer of 2011, the U.S. Fed’s Q.E. stimulus measures restrained the USD, promoting widespread strengthening of emerging market currencies. Over that period, the Indian rupee gained 13.9%, the Russian ruble gained 22.9%, the South African rand gained 36.2%, and the Brazilian real gained 37.3%.

Then, as the U.S. housing market and consumer spending started to recover in late 2011, the USD began strengthening, pulling foreign currencies back down again. Such volatile pushing and pulling on currencies destabilizes economies, as interest rates and other monetary policies need to be changed frequently and quickly.

Yet all of this turbulence in the currency markets could be avoided almost completely if the universal reserve currency were comprised of a basket of global monies instead of just one. After all, don’t money managers warn us against putting all of our investments in just one company stock? Don’t they advise us to diversify our portfolios with multiple holdings across numerous sectors?

Just as mutual funds comprising 20, 30, 40 or more companies are less volatile than just one or two stocks, so too would a global reserve currency comprised of 20 or more currencies solve the problem of massive moves up and down in emerging market monies.

Excessive volatility in currency markets affect a nation’s ability to pay debts, finance government expenses, and keep the economy moving. With so much riding on the stability of money, you would think someone would have called for a composite global currency by now.

The Global Reserve of Choice

Well, they have. Pundits have been proponing a new global money for over a decade… gold. Since it is not based on the economy of any one single nation, no single government’s policies can drastically alter its value. To a certain extent, they can – but not to such drastic levels as we have seen in the USD.

Do you have a diversified currency reserve in your portfolio? U.S. Fed policy is still ultra loose. Even with talk of bond purchasing reductions, interest rates will still remain near zero for at least another two years. And even then they will increase slowly.

Then there is the ever looming threat of war in the Middle East, which hurts all currencies relative to gold, including the USD.

Add gold’s limited supply, which is even more constrained by all the mine shutdowns over the past year, and you have a well supported case for gold as a must-have component in any portfolio.

Joseph Cafariello


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