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The announcement of the formation of the BRICS bank will have as much an impact about how the non-G7 countries manage their economies and their foreign reserves, as it does on the intellectual discourse. The development priorities and agenda which was hitherto set by western experts responding mostly to western priorities and notions will now have to compete with an intellectual tradition that is and can be very different, says Mohan Guruswamy.
The BRICS summit has announced the setting up of a BRICS development bank, on the lines of existing multilateral institutions like the World Bank and Asian Development Bank, headquartered at Shanghai.
The BRICS bank envisages an equity base of $50 billion (about Rs 300,000 crore) shared equally by the five founders. It also envisages a further $100 billion initially as advances by member countries. These advances will be in the shape of subscribed bonds with countries subscribing them according to their capabilities. Thus if China even subscribes to the most of the bond issues, it will not make a difference to how the funds are administered as that will be managed by the banks management vested according to their equity.
This is unlike the World Bank, where some are more equal than others. For instance the Indian nominated director has absolutely no say on critical policies that are set by the US appointed President and western European directors.
The announcement of the formation of the BRICS bank will have as much an impact about how the non-G7 countries manage their economies and their foreign reserves, as it does on the intellectual discourse. The development priorities and agenda which was hitherto set by western experts responding mostly to western priorities and notions will now have to compete with an intellectual tradition that is and can be very different.
For instance western theorists have for long rejected state owned companies as wasteful and inefficient, but China has proved that SOE’s can be economic drivers and major exporters, and also very profitable. Similarly the co-operative sector, largely rejected as Marxist idealism, might now find a new relevance. Again industrial investment, now entirely left to the western-dominated private sector, might find support.
Intellectuals are as prone to herd behaviour as any other herd. They veer towards the money and by the general prevalent economic policy consensus, right now the Washington consensus. This has as its main priority the maintenance of the status quo now tilted wholly in favour of north America and western European interests. By encouraging a different way of thinking and exploring different intellectual possibilities, we might see the beginning of a global intellectual churn that will expose the prevalent casino capitalism for what it is and how vulnerable it has made global economic and financial order to the predations of western merchant banking. Clearly the impact of the BRICS bank is going to be more than economic and financial.
The BRICS bank is the first step towards reforming the world system. It has to be read against the decision of the BRICS nations to do trade more with each other on the basis of currency swaps. To understand the importance of this, it would be necessary to understand the flaws and inherent weaknesses in the existing international system, which is in a shambles.
The world barely escaped a meltdown when bank after bank either failed or were on the verge of failing in the US. The US administration of President Barack Obama fashioned out a rescue by pumping in almost a trillion dollars to shore up the banks and save the giant US automobile industry, which is still that country’s major industrial driver. This money was made available by putting the printing presses of the various US Federal Reserve Bank’s on overdrive.
Little wonder then that the US dollar is devaluing against most world currencies. But the problem is that the US dollar is the world’s preferred currency. Today almost 61 per cent of the world’s reserves are held in US currency. Another 24.5 per cent is held in Euros. This clearly indicates that the US is the world’s preferred banker. On the other hand if the US continues with its profligate ways and keeps adding to the supply of dollars, they value of dollar reserves will keep dwindling.
Now let’s turn to have the system actually works. Countries like China and India produce goods and services at low cost for consumption in the US, which in turn pays them in dollars, which they in turn deposit in US banks. Give or take a little.
Since money cannot sit still, this money in US banks is then lent to Americans, who today have the highest per capita indebtedness in the world, to splurge on houses, cars, plasma TV’s, computers and play stations which they can often ill-afford.
This was well understood, but like the people who kept investing with Bernard Madoff, countries like China, Russia, Japan, Kuwait, India and others keep investing in US securities at interest rates mostly between 1-2 per cent. Thus, in effect the rest of the world was plying the US with cheap credit, encouraging it to splurge even more. Unfortunately there was and is no global regulator to caution the US on its profligacy or force it to mend its ways.
The Breton Woods Conference of July 1944 took place under the fast receding shadow of the WWII and when the US was literally the last man standing. All other pre-war powers including the victors were in shambles. The US was then much more than now the world’s dominant economy and military power. The economists John Maynard Keynes of Britain and Harry Dexter White of the US led the teams to draft plans to set up a system of rules and institutions to regulate and manage the international monetary system. The immediate result was the establishment of the IMF and the World Bank.
Lord Keynes had in mind a more elaborate scheme that called for the establishment of an international reserve currency but this had to be shelved in the face of American obduracy. Keynes' proposals would have established a world reserve currency (he proposed it be called ‘bancor’) to be administered by a central bank. This bank would have been vested with the possibility of creating money and with the authority to take actions on a much larger scale.
In case of balance of payments imbalances, Keynes recommended that both debtors and creditors should change their policies. As outlined by Keynes, countries with payment surpluses should increase their imports from the deficit countries and thereby create foreign trade equilibrium. Thus, Keynes was sensitive to the problem that placing too much of the burden on the deficit country would be deflationary.
But the United States, as a likely creditor nation, and eager to take on the role of the world's economic powerhouse, baulked at Keynes' plan and did not pay serious attention to it. The US contingent was too concerned about inflationary pressures in the post-war economy, and White saw an imbalance as a problem only of the deficit country.
Although a compromise was reached on some points, because of the overwhelming economic and military power of the United States the participants at Breton Woods largely agreed on White's plan. As a result, the IMF was born with an economic approach and political ideology that stressed controlling inflation and introducing austerity plans over fighting poverty.
But the fact that the US has been the world’s biggest deficit country for several decades and seemingly least concerned about it seems to have eluded the IMF. This and the fact that the US dollar has become the world’s preferred reserve currency (63.9 per cent) is now the root of the world’s economic problem.
This international system was unilaterally abrogated when in 1971 US President Richard Nixon US delinked the dollar from the gold standard. In the absence of a standard and a useful regulatory function for the IMF, coupled with the Reagan/Thatcher era that followed, the great private banks were given a license to run amok. We are now reaping the bitter harvest. With the US dollar as the world’s preferred reserve currency, the US and its even more profligate citizens have an apparently endless access to easy credit to satiate their sundry appetites. In this way the ever growing annual US trade deficit becomes the de facto engine of growth for many economies, such as China and the ASEAN countries.
In the past few decades the GWP has been growing at a much faster rate. In 1985 it was growing at 2.76 per cent. In 2005 it grew by 3.56 per cent. Much of this is due to the changing of gear in countries like China and India that began their great leaps forward. China’s growth in particular has been truly astounding. The growth trajectory of these countries has made people to review long held notions about how this century is going to shape up. It seems that in 2050 it will indeed be a very different world economic order. The firm of Goldman Sachs, the major survivor of the Wall Street shakeout has made projections of major GDP’s and this is how the picture is.
This may be or may not be. But the world is a rapidly changing place. The economic balance of power is shifting towards Asia. Like Communism the ideology of the Washington Consensus rammed down the world’ throat has been proved to be a failure. It is time we begin to think differently.
Many think that the world’s four fastest growing economies Brazil, Russia, India, China and South Africa (BRICS) must now become the basic building bricks of the new order. That’s why they are now meeting at the highest levels so often. But it does not seem that they have a plan or agenda. Interests often conflict. If the US reins in its deficit, China has much to lose. The 2009 slowdown cost it over 22 million jobs. India’s GDP dropped two points. Russia’s oil revenues dropped off dramatically.
Yet it devolves upon these five growth engines to bring more order into the world system. Casino capitalism can no longer be the guiding ideology. It must be swiftly discarded and a more responsive and intelligent system best suited to all and not just the USA is the need of the day. It is time we revisited Lord Keynes’ proposal for a global reserve currency and consider establishing a system to regulate and manage it.
The US and even the Euro zone will not want to relinquish the duopoly they have established whereby 91.4 per cent of the world foreign reserves are held in their currencies. The dollar alone accounts for 63.9 per cent of reserves. While the US’s own foreign reserves stand at a measly $148 billion the rest of the world has $11,864 billion in reserves.
China’s reserves alone stand at $4,009 billion while Russia’s is $467 billion. India is way behind here with only $315 billion, but this is still 50 per cent more than that of Germany, twice as much as those of and France and Britain. Clearly the time has come when we must put to work our money for ourselves and not be vulnerable any more to the gambling and speculative predilections of the so-called and over paid professionals in Wall Street.