Currencies And Geopolitics

Zoltan Pozsar is back with his stories about “Bretton Woods III” and the petro-yuan. (The original report is presumably for bank clients, but I found this summary by ER Valasco.) Although developing countries trading with China might take these developments seriously, from the perspective of the developed economies, how third parties arrange their affairs has limited domestic impact.

I initially had a longer response, but once I looked it over, I decided it was too weak. I will instead offer a relatively brief response.

The first thing to note is that the bulk of the thesis revolves around China securing raw materials, particularly hydrocarbons. One cannot completely brush off the implications, but these are driven by real geopolitical forces. It is clear that Putin’s disastrous foreign policy decisions have pretty much guaranteed that Russian energy will mainly be flowing to China and India for some time. The problem is that is less clear what the advantage are for countries in the Middle East to lock their exports to China, and not the highest bidder.

The currency angle is the problem with the thesis. Unless the yuan is fully convertible, it is not an attractive currency to hold reserves in. And even if those reserves rise — so what? By their nature, accounting identities have to hold. Any outflow from developed country reserves into China must be met by a matching outflow from China — or China’s trade balance has to correspondingly contract.

One of the advantages of Modern Monetary Theory (MMT) is that it tells us that reserve currency status is not some magical thing that creates financial alchemy. Instead, it has the tendency to push the reserve country’s currency to overvalued levels, creating a trade deficit (that allows for reserve inflows in the absence of capital outflows).

So long as a country is not too dependent upon strategic imports, it is free to float its currency. For the developed countries as a group, the only plausible strategic import is energy — the developed West are major food exporters. Barring a loss of energy imports — which is going to be a problem regardless of the currency arrangement — Western countries will just let their currencies float and let monetary and fiscal policy deal with inflation.

In summary, other than in the scenario of energy flows being cut off from the West, pronouncements from the “BRICS” countries about new currency arrangements will only matter for the countries involved.

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(c) Brian Romanchuk 2022