BRICS PLUS: Will it work? Probably, and it will surprise.
Underestimate the BRICS PLUS at your peril
The goal of this newsletter is to help those without financial backgrounds learn more and help them navigate some of the challenges that lie ahead, personally and professionally.?
There is a second aspect that is about strategy, and may be of interest to those who enjoy it: but be warned, ‘there are only two types of forecasts: wrong and lucky’. So this piece is split into two parts. The first, educational and the second strategy. For more on the second part, follow the instructions at the end.
Introduction
The idea of a competing bloc to the G7 or G20, in the form of the BRICS Plus was met with something between amusement and derision.
An acronym coined by a banker, two decades later has turned into a peculiar politico-financial forum (link) of international misfits. The common denominator was fast growth. Critics question its purpose, and point to a lack of common values. I disagree. Whilst its future is far from clear, it is a project that has legs, and will likely surprise critics. I address why in part two. One thing is for certain, it is a great learning opportunity to discuss international trade and finance.
Fundamentals of trade and finance. Part 1: Trade
In neoliberal economic theory, the BRICS Plus has no economic purpose. Economic principles posit that countries should trade based upon comparative advantage as David Ricardo explained (link).
In which case different nations develop national champions. This is self evident today with nations dominated by certain industries: Taiwanese semiconductor companies South Korean electronics companies and heavy industry; Japanese automobiles, electronics, etc; and British banking. The US, still the world’s economic superpower, contains a panoply of leading industries. The rest of the national economy is made up of smaller, but in some countries very valuable, companies.
A picture of trade
Like any ecosystem, it evolves continuously and gets more complex with time. These international champions dominate their nations and through lobbyists shape government policy and trade agreements, entrenching further advantages, domestically and internationally. The best and brightest from their education systems are drawn to these national champions.?
The winners are the global consumer. The disinflation caused by this process was witnessed during peak globalisation. And so when you hear populist politicians ask why we don’t build cars anymore, herein lies the answer. It is because, somewhere else, there is an entire economy that has evolved over decades to produce cars cheaper and ship them around the world, and recreating that eco-system is a multi-generational exercise. And these principles extend beyond complex manufacturing to farming, and virtually all aspects of the economy.?
It is also easier to understand the role of business lobbies. In theory they are a needed bridge between business and government to shape policy.
Under the modern system it is not just the poor individuals within nations that live on the edge, but also entire nations. That is why despite the abundance of food on the planet, countries still fall into famine today: Madagascar, Somalia, and Yemen for example. To understand this better, let us consider a national equivalent of Maslow’s hierarchy of needs (link). At the base they need energy and food. Today to be competitive they need infrastructure: utilities, roads, airports and broadband.?
As with the example of building cars in Britain, all of these essentials are likely provided cheaper by some international conglomerate. That is why nationalists are often wrong to promote ‘self-sufficiency’ - demanding that the country should grow or build various essentials domestically. The moment that a country embarks on that path, they will pay (a lot) more for those goods than the price on the hyper efficient international market, delivered by the best producers in the world. It is possible to build a national champion that is globally competitive, but it will take time, dedication and resources.
So in order to purchase essentials, each country needs to export something of value to others. The vast majority of the two hundred odd countries in the world fail to develop anything complex that is internationally competitive. Many rely on various forms of natural resources: from Caribbean islands that rent out their glorious beaches, to oil rich states that lease out drilling rights. Those with neither, often expatriate labour leave those shores to work (sometimes in quasi-indentured) conditions and remit hard currency back.?
So you get a picture of international trade. National champions of successful countries produce their products most efficiently, and have often built up that status over generations. All countries need to export something in order to purchase essentials they need.?
So what happens when a country is unable to export goods or services sufficient for its needs? The same thing that happens to individuals: borrow or sell assets. That question leads to the second part of this explainer: international finance.
Fundamentals of Trade and Finance Part 2: Finance
When a country exports less than it imports (runs a Current Account deficit), it can fund the difference by selling financial assets: usually government debt, but other investments too. For example in the UK, investors are drawn to our property due to its robust history of property rights. So the UK may need to import most of what it needs, but people want to buy UK property, and so the balance of payments is matched. I.e. the country’s Capital Account (the inflow of investments) can fund the Current Account deficit. Together they make up the Balance of Payments.
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A free floating currency, continually adjusts for these demands. So the UK pound has varied between two dollars for one pound and almost parity (one pound is one dollar during the Liz Truss premiership) in the past fifteen years. Over the past century the UK pound has deteriorated from four dollars to one pound - largely a function of the rise of the transition from one global superpower to another. The most recent collapse in the pound from two to one, can be attributed partly to the structural deterioration of the banking sector (through changes in internationally driven regulation) to trade uncertainty about the outcome of Brexit.
For a reasonably competitive economy, such a devaluation provides an opportunity to reset. The goods and services become cheaper and more attractive and new funds flow into newly blossoming sectors and the currency appreciates again. That is the epitome of neoliberal theory in action.
For the vast majority of countries in the world, that does not occur. Many economies are structurally uncompetitive: i.e. despite frequent currency devaluations, they are continuously unable to run a sustainable balance of payments (export what they have to for the imports they need).?
Let us take Turkey for example. Its currency, the Lira, was circa 1500 to one dollar in the early 90s. By the mid nineties it was circa TRL 50,000 (to one dollar) and at the end it was around TRL 1.5 million to one dollar. It then rebased to the New Turkish Lira at 1.5 to one dollar. Today it is over New TRL 20 to the dollar. In the space of a mere 30 years, it is worth less than one sixteen thousand of its value to the dollar. The British pounds four fold fall over a century looks tame by contrast. This is all against the US Dollar, which some economists argue has lost 99% of its purchasing power (i.e. the price of essential goods in USD has increased 100 fold) over a century - but that is a different discussion about Fiat currencies.
Neither is Turkey unique. Most of the 200 countries in the world struggle with this problem of creating competitive and dynamic economies. Their failures are often masked by periods of global growth. However, when there is a downturn, their currencies devalue the fastest. Fixing that is complex.
International financing and emergency funds
When a country is unable to buy those essentials (oil, food, etc) chaos often ensues. As they saying goes ‘you are only nine meals away from revolution’. A notable feature of the Turkish economy is that regardless of the downwardly spiralling currency, the price of staples, specifically bread and petrol were always held steady: i.e. subsidized by the state. So even though the currency is weaker, and so oil costs more to buy, the state contributes to keep the price of bread down at the gas pump. This is the case in many developing countries. Simply put when GDP per capita (the value of the economy per person) is below USD 5,000 it is difficult for individuals to pay the ‘fair price’ or international price for oil, so the state subsidises it (or else the economy quite literally grinds to a halt). However, as your currency becomes weaker those subsidies cost the state more and are eventually unsustainable.?
As these subsidies wreak havoc on state finances, countries fall further into distress. For those unable to access the capital markets (funds from investors), emergency funds are accessible from supranational lenders. The biggest of these providers are based in the US, though that is slowly shifting.?
In the post World War II era, the US emerged as one of two global superpowers and the only one promoting neoliberal, capitalist policies. It set up a global financing infrastructure, starting with the Marshall Plan to reconstruct Europe, the eurodollar (the capacity to borrow and transact dollars outside the US), and US dollar lending institutions: the International Monetary Fund and World Bank (and today a number of other supranational institutions - IBRD, EBRD, IADB, ADB, etc). These institutions, whilst global in name, were heavily influenced by Washington, and often headquartered in the US. ??
And so when countries face a Balance of Payments crisis (their domestic currency is worth less, or worthless, and they lack hard currency assets, and can’t buy essentials for the economy - oil, wheat, etc), they can turn to supranational agencies.?
Those agencies will lend funds, often based upon conditions that demand reforms - cutting government spending, addressing corruption, implementing political reform, etc.?
And so we see that Fiat currency, can either be valuable (considered a hard currency) or like confetti: its status depends directly on the capacity of a country to trade and deliver exports sufficient for its needs. The currency are merely the tokens that are exchanged domestically to attribute value. And when a country cannot trade or is not economically competitive, the currency rapidly devalues and eventually collapses.
Each country can print as much of their own money as they they need - but the oversupply of Fiat money eventually leads to hyper-inflation (as the Weimar Republic of 1920s Germany, Zimbabwe and Venezuela demonstrate). At the height of some of these examples, so much money was printed, it was more expedient to burn money for energy, than purchase coal or wood. There is an anecdotal joke from Weimar Republic Germany that goes like this:
“A man carrying his money in a wheelbarrow was robbed. The robber threw out the money and stole the wheelbarrow.”
That in summary is the current world order. In this theoretical world, national champions and what they produce are traded efficiently, on an international market-place. They will produce everything from the cheapest food to cars. In theory trade deals are easy to strike, and the result is a complex web of trans-national trade, where the winner is the global consumer: able to buy the best product at the cheapest price.?
When countries fail to be competitive or self-sustaining, they can devalue their currencies, to make their markets more competitive. However, it comes at a price: goods they need get more expensive. If they devalue too far, then they cannot even purchase essentials (food and energy), and societies begin to breakdown. Then countries can turn to the IMF or World Bank, and loans will be extended based upon goals for economic reform: these range from cutting government spending, to improving legal (property) rights.?
From this theoretical perspective the BRICS summit is an endeavour in futility. In this theoretical world the Washington Consensus is apolitical and neoliberal solutions are the answer to every country’s woes.?
So the BRICS PLUS is redundant. Whatever this group of countries agree, their economies need to be efficient, they need to trade on the international market and exchange their goods for others and so in an efficient world of free trade, what does the BRICs achieve? On paper, not much. Hence the derision.?
However, that’s just the theory. The opportunity for the BRICS Plus lies outside of the realms of academia.?
So if the economics don’t work, what exactly is the new BRIC PLUS entity meant to achieve? We explore this in Part 2. This piece is less educational and more about geopolitical and economic strategy. ?
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