BRIC Nations Getting Bolder

The BRIC countries (Brazil, Russia, India, China) had a much-ballyhooed meeting to discuss global economics and shake their fists at the U.S. powers that be for crushing their U.S. investments.

We have commented on their plans and purposes on numerous occasions. Now that the meeting has come and gone, let’s take a serious and sober look at what these countries are about, and why they are doing what they’re doing. Assuming that they are even doing anything at all…

First let’s look at the growth of these four dynamic economies. In the GDP growth department, last year India came in at 6.7%, Russia at 8.1%, Brazil at 5.08% and China a staggering 9%. Compare that to the United States’ -6.3%, and you start to get an idea about why they consider themselves superior to America and her economy.

No matter how much you may think those numbers are manipulated, the bottom line is that they are all ahead of the West by light years. They are in regions that were once shackled by the constraints of socialism and outright communism, and are just now breaking free into the light. (Meanwhile the United States is steadily advancing its war on capitalism by increasing debilitating taxation and regulation by the day!)

To put this even more into perspective, the United States has a GDP of about $14 trillion annually. Comparatively, Brazil is at $1.9 trillion, Russia at $2 trillion, India at $1.2 trillion, and China at $4.3 trillion. That means that the combined output of these four nations barely equals two-thirds of the United States.

The GDP per capita, where it is estimated what each person produces each year, also shows some marked disparity.

For the United States, GDP per capita is just under $47,000. Brazil is $8,200, Russia is $14,600, India is $1,000 and China is $3,200. Once again, in terms of output, the United States is far and away the leader, nearly doubling the output of the other four nations combined.

Additionally, the percentage of people in these countries that are below poverty level is shocking. The World Bank estimates that 42% of India’s population is below the poverty level; In China, 10%; Russia, 16%; Brazil, 22%. As that sinks in, also keep in mind that the World Bank defines poverty on an international scale as living on less than $1.08 per day

And not only are these people poor, there is no infrastructure in place to facilitate the increase of wealth among a large portion of their citizens.

Please note, I am not talking about wealth redistribution by government mandate. That will ALWAYS make the poor even poorer. As a matter of fact, it will make the rich poorer, also.

But as a rising tide does lift all boats, severe divergences in wealth from various parts of the population is indicative of markets that are not functioning “normally.” We see this in the United States as well, as government regulation interferes with properly functioning markets and facilitates the destruction of the middle class, leaving only the rich and the poor — not to mention a widening chasm between the two.

How do these relatively “poorer” countries get to call the shots? Why are they influencing policy discussions around the globe? Why do markets tremble when they speak? What is going on here?

You may remember the axiom of Baron Acton, “Power tends to corrupts, and absolute power corrupts absolutely.” Let us be careful here. Absolute power does not corrupt absolutely. God, of course, is exempt, however, in the world of men, it is indeed seemingly axiomatic that the more powerful a man becomes, the greater the temptation to corruption.

No place is this more true than in politics (except maybe religion!). And frankly, it doesn’t matter whence a man hails, what color his skin may be or even what language he speaks, the intoxicating effects of power are universal.

The four BRIC nations have been drinking deeply from this well. They want more power. They want more influence. They want more wealth. In short, they want more. They want what the United States has flaunted. They want the American dream. But they want it wrapped in a turban, served with fine vodka and no more white rice.

They’ve also learned the meaning of another English proverb: “Strike while the iron is hot…”

There is no doubt that that the international media often depicts the United States as an absurd mix between the playground bully and the dunce in the corner. When was the last time you heard an international story praising the U.S. position on anything? From economics to foreign policy, bureaucratic regulation to welfare statism, the United States has become the international piñata.

The fact is, many nations — especially BRIC nations — would like to increase their own amount of “loot” by beating it out of the United States.

The question is, can they do it? Can they decrease the usability of the U.S. dollar while increasing their own. The United States seems fairly determined to bring the first portion to pass by its own volition. The BRICs may not need much help in that arena. But does that automatically guarantee them a seat at the table? Does a U.S. decline mean, ipso facto, that any one, or all four, of these countries gets moved to the head of the class?

I’m not sure that question has been thought through. Frankly, I believe they just see an opportunity and figure they will jump on it. But only lightly. Because there are repercussions, and some of them are not so favorable.

As they’ve sent up a hue and cry for a supranational currency, I have to wonder if they have really learned any lessons at all. Their complaints have centered around a single manipulated currency at whose mercy they find themselves. They seem to intuitively know that a fiat currency system is flawed. It is flawed because men are easily corrupted.

After all, what good is the guilt of corruption, and who would want to bear that burden, unless they could effectively salve their conscience by the increase of wealth? In short, power is rarely of any use to men unless it results in more money. That’s what the United States is being accused of (and rightly so). We have taken our position of unquestioned strength and used it to create the illusion of wealth at home, at the expense of our neighbors. And now the neighbors don’t like it.

But what is their solution? More of the same. Another fiat currency. Actually, a currency made up of a basket of currencies. This should really strike us as hilariously funny, if it weren’t so sad. And by sad, I mean stupid.

It’s like draining bad oil out of a motor and replacing it with equally bad oil. Or like removing a tire that has a nail in it, only to replace it with one that is dry rotted. Or like trading a job you hate for one that will eventually kill you. Or like… well, I hope you get the picture. Essentially, the solution they have put forward is no different from the problem they’re attempting to repair.

And that’s not the only problem…

Here’s what I mean. Both India and Russia still receive foreign aid from the United States. They’re rather like a rebellious teenager who takes potshots at their parents while holding out their hands for cash and car keys.

Beyond that, consider that the BRIC nations hold over 30% of the U.S. Treasury market. That’s a lot of eggs in one basket. So when they start grumbling about policy, they can really strike a fire. On the other hand, upsetting the basket breaks a lot of their own eggs.

The problem is that they must measure their blows carefully. If memory serves correctly, it was China who fired the first shots across the bow of the U.S. economic state. But then, like a playground dog pile, Russia jumped on top as well. Then, lo and behold, the statements are retracted (or at least ameliorated!).

This has gone back and forth, and I imagine it will for some time, since they can ill-afford to knock the United States completely off its horse. To that end, the BRICs have discussed intermarket trading with each other while bypassing the U.S. dollar and talking about a new currency reserve.

Now this is some pretty braggadocio poppycock from upstart powers that “wannabe.” It was just a decade ago that Russia scored big on the international monetary scene by defaulting on a $40 billion dollar debt. (That was back in the day when a billion dollars actually meant something!)

If that were you or I, we’d still have that default on our credit report! And no one would let us forget it, no matter how well we had rearranged our household finances.

So then… have these four countries turned the corner financially? Have any of them got the economic muscle to merge the other three into a formidable monetary force against the United States? Let’s take a look.

Last year during the first leg of the global economic collapse, commodities took a real whack. So did the economies associated with their production and distribution. That means oil — and that means Russia and Brazil.

Even though the Russian stock market climbed more than 6,000% in the previous 10 years, it fell 80% in the eight months of crisis. 80%! While it was the worst of the BRIC alliance, Brazil fared little better. Its equities were down 60%!

And how about the other two BRICs in the wall? Indian stocks were down almost 65%, and Chinese companies… a whopping 73%!

We also now know that while Russia’s equities were tanking, so was their currency, the ruble. After losing nearly 60% of its value, the bleeding was only stopped when Russian authorities jumped in and sold nearly $200 BILLION worth of dollars to support their currency in crisis. That was nearly one-third of their currency reserves — up in smoke to defend an already overvalued currency.

Now, after all that, they start talking about the concept of buying one another’s bonds, and lessening their investment exposure in the United States.

Now let me ask you a simple question: If you had to buy the bonds of either the United States or Russia, which would make you feel safer? One that defaulted on their debt not so long ago and was just hemorrhaging the value of their currency in the last six months? I’m not saying that America is rock solid as an investment, but if you have to pick the lesser of two evils, who you gonna choose?

At this point the U.S. dollar index is hovering around 80 against the weighted basket of currencies by which its value is measured. Last June it was around 72.50 at its lows. That puts it up about 10% on the year.

Conversely, the rupee, real, and ruble, even after some recovery, are still down 35%, 25% and 35% respectively.

Also, consider that from top to bottom of the crisis moves, the ruble was down nearly 60%, the real nearly 70% and the rupee down 30%.

China, of course, has continued to peg its currency, the yuan / renminbi, to the dollar, so such fluctuations, “don’t exist.” Because when a nation, like China, pegs its currency to another nation’s currency, such as the United States, the foreign authorities continually buy and sell their own currency to keep it in a trading range against the other. That way it never suffers from severe fluctuation shock.

But when all is said and done, this betrays the fragility of each of their economies, and how connected they are to dollar based difficulties. So as they chop away at the tree, they had better be careful lest it fall on them.

It is hard to say what the future may bring in terms of changes, but even now, although the BRIC’s are referred to as an alliance or “federation,” the only two countries that have a trade relation of any substance with one another are Russia and China. India and Brazil see very little trading action with them, and are not even in their top seven in terms of import/export volume.

Just some things to keep in mind as we take a closer look at the news…

BRICs Buying Less Debt

Last week we talked about the Treasury Income Capital (TIC) figures, which shows foreign net purchases of long-term U.S. securities. Essentially, it’s a measure of how foreigners are funding U.S. debt.

The headline April TIC number fell to $11.2 billion from the $55.4 billion recorded in March.

Additionally, we’ve learned that the current account deficit for Q1 was a negative $101 billion. The TIC data for January through March showed foreigners funding only $40 billion of that deficit. That means effectively we were a negative $61 billion in the hole as a country for Q1. We are still paying our bills — so where did the money pay them come from?

In line with our theme for the week, China’s purchases of U.S. Treasuries decreased to $10.3 billion from $14.8 Billion. Russia and Brazil showed small outflows in April, which was similar to the past few months. But the biggest change came from Japan, which showed an outflow of -$1.2 billion, way down from the previous $23.2 Billion inflow.

While one series of number releases does not make a trend, one can’t help but wonder where this will lead. As we covered last week, there are only two destinations that I know. If foreign entities are unwilling to fund our deficits with the higher Treasury yields (up from 2.1% to 3.75%), one of two things will happen:

1. Yields have to go up more, raising rates across the spectrum from mortgages to loans to credit cards, thus inducing a second wave of “Credit Crunch”

2. Or foreigners will NOT fund our U.S. deficits. That means the Fed will purchase more U.S. Treasuries, and it means they will print more cash to do so.

Neither of these choices bodes well for the United States or the U.S. Dollar. Only time will tell us if April data was a fluke month or if it was a sign portending things yet to be.

But not all is dreary in the world. Our friend Chuck Butler over at EverBank had this to say:

“It seems that Australia’s government has decided to put government backing on state-issued bonds like the QTC’s (Queensland Treasury).

“This is HUGE for these bond issues, especially since Australian states were seeing downgrades in ratings! The country of Australia has a higher rating, so these bonds will also inherit that rating, since the government is backing them!

“However, this will tighten up the yield on these bonds, probably by about 10-15 basis points.

“Why is this important? If the QTC bonds now have a higher rating, more institutions will be able to buy them. That means more investments flowing into Australia, and more cash flows into Aussie dollars!”

The thing here is that in the long run, this is good for the Aussie dollar!

Thanks, Chuck! Notice he said, “in the long run.” Since that news broke last week, the Aussie dollar has been on a fall. But as soon as it firms up a bit, we’ll be jumping back on board!

And here’s a little good news from Stateside (especially for the Fed). Consumer inflation dropped 1.3% over the last 12 months, the biggest decline since 1950. What? No inflation in the United States? Hey, Ben! Keep those presses rollin’! We can continue to “stimulate.” Good Lord, deliver us!

Also, some other good news — continuing claims for unemployment finally dropped last week, ending their heartbreaking streak. Hard to say what this week will hold, so we’ll wait and see.

We will also be looking at the Treasury auction this week. The U.S. government will be issuing a record $104 billion of 2-year, 5-year and 7-year Treasury notes between Tuesday and Thursday. Traders are watching these auctions because of their sheer enormity and also because it will shed some light on whether bond buyers are willing to fund the growing U.S. budget deficit. If demand comes up short, the dollar could get whacked. But, as always, it is not that simple.

You can’t just sell the dollar if the auction appears weak. Because weak demand may drive up yield rates, which will be good for the dollar, as long as there are buyers. And as I’ve covered above, there are likely to be more dollar buyers than there are those who buy everything else.

Thus as we come to the end of our musings and examinations today, we are looking at consolidations taking place.

The euro has been locked in a down drifting channel but remains in a larger uptrend. And now it is hanging around a crossroad. Yogi Berra said once said, “When you come to a fork in the road, take it.” We are currently waiting to see which road the euro will take. Yesterday’s move up was unusually strong and uncharacteristic. We will watch to see if it was just short covering or a real rally beginning.

The pound can’t quite seem to make up its mind either. It has out-appreciated its European counterpart and moved higher. But we may see some weakness to come, as it is having difficulty pressing up at this level. If it breaks through, however, we could be in for another extended run.

The Aussie has drifted further down, but has not violated its 30-day lows. Just about time to take a new position here. But we need to wait for a bit more confirmation.

Today the Fed will announce interest rates. No one expects that they will be changed. But we do expect to hear something on the Fed’s view of the economy. In his last appearance before Congress, he stated in no uncertain terms that the deficits could not continue. Now deficits are not really his department. That is the domain of Congress. But if he hints at the fact that the existing Treasury buy-up is going to be stopped at $300 billion, this could be massive for the dollar. There are only two paths ahead of us.

Bernanke knows as well as any, that inflating the currency further will lead to dollar destruction. It is my feeling that as the dollar has seen a sell-off, that this month they are going to stand on the other end of the see-saw and talk up some dollar strength.

Bill Jenkins

June 25, 2009

The Daily Reckoning