The extreme dominance of the share of global GDP after World War II by the United States was a historical accident, and so the relative rise of other economic powers was inevitable. Meanwhile, the eagerness of the United States to use sanctions as a foreign policy tool is going to create incentives to develop mechanisms to do an end run around those sanctions. Nevertheless, the geopolitical system is far more stable than is commonly described. (I will enter a geopolitical tangent later in this article to justify that claim.)
Since I have ranted about this repeatedly, I am just going to do a “greatest hits” refresh of my economic arguments.
“Reserve Currency Status”
My intellectual filter is that anyone discussing “reserve currency status” in relations to countries after the demise of Bretton Woods does not know what they are talking about. Every semi-liquid developed country government bond market is seeing reserve asset allocations (IMF table). Reserve asset managers are large bond fund managers, and as long as the market is big enough to support them, they are going to buy the bonds. In other words, almost all the developed economy currencies are “reserve currencies.”
The USD dominance of reserve asset allocations is going to mirrored by allocations by private sector developed bond managers. No sensible investor wants to put a lot of money into a market dominated by a cabal of local investors who would just love to squeeze foreign bond investors who have not done their due diligence. The bond market has to be deep enough that shenanigans are difficult to coordinate.
The euro is a serious currency. The yen is also tied to a strong economy, although I see limited domestic appetite to absorb foreign reserve inflows. The United Kingdom would punch above its GDP weight in attracting financial inflows if the toffs were not so busy dismantling the economy. Other developed bond markets are tied to solid economies, but the depth of the bond markets are limited.
Finally, the USD credit markets are overweighted in allocations because of network effects. A major driver is that exporters to the USD want to issue in USD to hedge their revenues. However, market size also matters for issuance. For example, when I was in finance, there was no CAD high yield market — issuers and buyers operated in USD so that they would be part of a diversified market. (Currency swaps can easily allow movement between CAD and USD.) The rise of other currencies should lead to diversification, but that would take time.
BRICS Economic Cooperation: So What?
Stories about greater economic cooperation between the BRICS countries — particularly Russia and China — make some sense. However, such a possibility needs to pass the “So What?” test.
A diversion of trade flows to occur between the BRICS bloc is by itself meaningless. To a certain extent, trade flows are fungible: if Russia and China divert production towards each other, other countries will reallocate their exports towards the countries that used to receive their goods. (For example, if Russia sends more oil to China, the countries that used to supply China with oil would send their oil to countries that used to buy Russian oil.) The only reason for an outsider to care is if the BRICS bloc attempts to cut off exports to outside countries, or charge excessive amounts for outputs they control. However, the only country within the grouping that might have economic leverage is China. Russia is a major commodity exporter, but it does not have a dominant position in their global production. The Russian capacity to take commodities off the global market is constrained by the need to earn foreign currency to finance its war-related imports.
Attempting to force outside countries to use a new “BRICS currency” runs into the problem that the only credible “BRICS currency” would be the Chinese renminbi (or something that is a close proxy for the renminbi). It would be difficult for the Chinese to get foreigners to hold the renminbi with the current capital controls regime. Invoking stories about “commodity-backed currencies” runs into the problem of how the currency is redeemed for the commodity in question. Who in their right mind would trust the Putin regime to hand over gold in exchange for rubles? In what sense can a major commodity importer like China back its currency with commodities?
Status Quo Coalition
My argument is that the form of global financial structures reflect the economic functions the trading system needs. The global trading system is slowly changing, and so the financial system slowly evolves (albeit punctuated by the intermittent crises of industrial capitalism). The people who are excited about gold or BRICS argue that geopolitics will provide the impetus to change. This is based on a faulty analysis of the international order.
Bret Devereux wrote an interesting article “The Status Quo Coalition” that expresses the situation well. I will not go into the full logic of his arguments, but I will summarise a key take away. A lot of international politics (and especially the geopolitical analysis that shows up in market commentary) is stuck in a pre-industrial warfare mindset. The destructiveness of conventional — and nuclear — weapons has outmoded logic that held before. It used to be economically profitable to swallow weaker countries, but that is no longer true. For example, even if we ignore Russian casualties, there is no way that the Ukrainian invasion will be an economic benefit if the discount rate on hypothetical future extraction flows is positive.
This has resulted in what Devereux has termed the “Status quo coalition”: a group of wealthy democracies that have a vested interest in preserving the status quo. This leads to behaviour that is missed by more traditional analyses.
So while I think the coalition may well have emerged without the United States, it is no surprise that, the United States being a thing that exists, the coalition is often regarded (wrongly) by Americans and Russian propagandists alike as simply a tool of American Imperialism – a collection of smaller states huddled around Columbia‘s skirts. That reading is a mistake and it leads to misjudging how the coalition will act, [emphasis in original] because the coalition isn’t bound together by American power but by common interests and so behaves differently.
That is, the “coalition” is not going to fall apart because of weakness in the United States; if anything, threats to the coalition make it stronger. The only real risk to the coalition is that American foreign policy becomes too erratic, and so the differing regions have to focus on their own defence. (Erratic American foreign policy is not a new thing; just ask the South Vietnamese.) That said, the end result is that new regional defensive alliances will bulk out their militaries, while trade flows are likely to continue as before — implying that the financial arrangements would not radically change.
The industrial democracies are not puppets of the United States that can be picked up in a balance of power shift. They are following their own interests, and generally have the resources to guarantee their own security. American dominance is convenient for them, and the only thing that would cause them to re-think their strategic options would be more erratic than usual policy shifts by the Americans. As long as that coalition sticks somewhat together, there is no reason for the the structures of global finance do anything other than slowly evolve in response to changing relative economic fortunes.
Appendix: Ukraine War
At the time of writing, the media is filled with “the Ukrainian counter-offensive has failed” stories. It is no secret that I hoped that the Russian defences would rapidly collapse. However, the outcome does conform to what I expected this spring — a war of attrition by the Ukrainian forces, countered by fierce Russian defence that was not willing to give much ground. (I expected the Russians to give more ground so that they would be mainly defending the much stronger second line of defences.)
The only reliable information for outsiders in this war are the changes of control of villages and towns (and to a lesser extent, recorded losses of equipment). An attrition war does not result in many changes of control.
The lack of a Ukrainian breakthrough is just another way of saying that the Russian military in Ukraine has not collapsed. Any breakthrough comparable to what we saw in offensive operations in World War II would put the Ukrainian army on the shores of the Sea of Azov, splitting the Russian forces in two, rapidly leading to the annihilation of one or both parts as a result of a logistical collapse.
Although the Ukrainians want that collapse to happen, they have been channelled into following “bite and hold” tactics. Relatively small assaults that capture a small amount of territory, and then digging in to hold the new gains against counter-attacks. (The “relatively small assaults” is a comparison to mechanised thrusts in World War II , where sometimes an entire armoured division might attack on a front a couple of hundred meters wide. If you watch a WWII documentary series, you will see many scenes of fields filled with advancing tanks. We are not seeing that kind of force density in Ukraine; we see companies attacking, not divisions or even brigades.) The Ukrainians are making some gains, such as the announced liberation of Robotyne on August 22nd. Although less dramatic than manoeuvre warfare, “bite and hold” was the technique used to break the back of the German army in World War I. (There are a lot of myths about World War I, see this article by Bret Devereux discussing how the stalemate on the Western Front was broken. Yes, I have been reading a lot of his articles.) There is no way of judging the success of those bite and hold tactics without reliable casualty statistics — which are not available to anyone outside the general staffs of the combatants.
Although the media is filled with speculation that Putin is waiting for the American Presidential election in 2023, the reality is that his troops have to survive not only this summer/fall, but a winter and following summer campaigns to get there. It seems unlikely that the artillery and drone capabilities are so evenly matched that the war will not be decided at an earlier date.