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Global Outlook

Not Just Another Anti-Dollar Alliance - The BRICS Bank

July 11, 2014, Friday, 14:05 GMT | 10:05 EST | 18:35 IST | 21:05 SGT
Contributed by eResearch

A new trade-stabilizing tool underscores real risk of long-term U.S. dollar dominance.

The World Cup home crowd's pain stopped in Brazil after the humiliating 7-1 defeat by Germany. Last week's article pointed to Brazil special advantages against regional rivals. Clearly, that was not the case against a Europe-based contender last night.

Fortunately, for local fans, Brazil goes up against the U.S. on another field next week - and this time with some real power players. The world scale team is led by China with India, Russia and South Africa as key participants as well.

In a few days, the Sixth BRICS Summit will put the final changes on a new financial architecture in response to an overdollared global economy.

The plan combines a monetary stabilization fund called Contingent Reserve Arrangement (CRA) with a development bank called BRICS Development Bank.

The CRA will have a total of $100 billion in capital - $41 billion from China, $18 billion each from Brazil, India and Russia, and $5 billion from South Africa. The BRICS Development Bank will begin operation with capital of $50 billion dollars, with contributions of $10 billion and guarantees of $40 billion from each of its members. The bank will be able to expand to $100 billion dollars within two years, and to $200 billion in five years; it will have capacity to finance up to $350 billion.

Normally, the United States is a member of, and a major donor to, each major multilateral development bank.

However, the BRICS Bank is not just another development bank. It is an anti-dollar alliance to wean the world off overreliance on the dollars - overdollaring.

The concept of overdollaring

Let's borrow a concept from the technology area, overclocking, and apply it to the U.S. dollar to explain our current monetary predicament.

Overdollaring is the process of making a currency or other component operate in international trade other than that for which the source currency is denoted for (hence the name 'overdollaring').

Prime examples of this are oil and other commodities. Net exchange rates and transactions costs and conditions may also be changed (lowered in favor of the buyer), which can increase the pace at which trades flow. Most overdollaring techniques increase commodity consumption, generating more inflation, which effects must be dispersed if the source economy is to remain operational.

Basically, it's been a historical mistake to use a country or single currency as the central measure to control anything on a global basis. Advocates of digital global currencies will point out.

Here are some current example and issues of overdollaring.

The Export-Import Bank . Proponents of extending the bank's mandate cite this as a way to rebalance the rules of international trade against unfair subsidies. Opponents claim it acts like a piggy-bank for corporate welfare and lobbyists. While it can win some votes and influence in Washington, ultimately this is another tool to extend the dominance of the dollar globally.

Global bank settlements . It seems like the U.S. government went to war against the large global banks attaching terms and conditions to individuals and entities from the prohibited destination country as part of its investigations. The response from abroad was overwhelmingly negative after BNP Paribas was slapped with a record $9 billion fine and a 1-year dollar trading ban. Bank of France's Governor Christian Noyer recently said, 'Trade between China and Europe -- do it in euros, do it in renminbi, stop doing it in dollars. This is an affair that will leave marks.' Michel Sapin, the French finance minister, more clearly called for a rebalancing of the currencies used for global payments, saying the BNP Paribas case should 'make us realize the necessity of using a variety of currencies.'

FACTA . The US Foreign Account Tax Compliance Act (FATCA) comes into full force on July 1, 2015. The newest extension of overdollaring will add significant new reporting requirement costs for financial entities across the globe. Many offshore-based investors, as well as those in the U.S. who invest abroad worry that when this comes into full force on July 1, 2015 some financial institutions might opt out of dollar-denominated transactions or not accept U.S. accounts.

The trade-offs are increasing economic consumption and inflation versus the source economic system becoming unstable if the currency is overdollared too much. There is also the risk of damage due to excessive inflation or debt generation. In extreme cases, costly and complex exchange rate devaluations, defaults or savings liquidations are required. There is a loss of trust too.

Don't blame it all on the dollar!!

Other countries need to start to plot out long-term strategies to find replacements to the greenback as the world's de facto currency.

China is already the prime mover on this. By 2015, about 30% of China's cross-border trade will be settled in the renminbi, also called the 'redback'.

Over the past few months, Chinese officials have been reportedly meeting and consulting with several Asia-Pacific nations to set up the still tentatively named Asian Infrastructure Investment Bank (AIIB). The AIIB is an open and inclusive platform that focuses on infrastructure and welcomes not just nations from Asia (except Japan of course), but others as well, including the United States and European countries.

With both the AIIB and BRICS Bank, China takes on a more central financing role that is independent of the current financial bureaucracy.

You don't have to be a sport fan to appreciate what happens after a humiliating defeat. What follows is a general loss of trust from supporters and a big loss of self-confidence for the team.

The United States government may just end up hurting itself with its tactics while it has the dominant position. Ahead there could be a serious tumble in the value of the US dollar, more wealth contraction, higher inflation via import prices, and less US wealth available to support US debt.

My take on this is that if you are concerned the U.S. won't be economically dominant in five years, start adding international equities in your portfolio now and support a return to a sound dollar.