Ooh Lula La! Brazil Wants To Dedollarize Too

By Michael Every of Rabobank

Friday saw US Treasury yields 10-12bps higher and the curve flatter after headline retail sales were lower but strong core, Michigan year-ahead inflation expectations leaped from 3.6% to 4.6%, the Atlanta Fed wage tracker showed steady *positive* real wage growth for job switchers and stayers, and the heads of JP Morgan and Blackrock both said they don’t see inflation falling back rapidly, and that US rates will stay higher for longer. The Financial Times (‘Why economists are learning to speak human’) also mentioned Polanyi’s view that markets sit on politics and society –e.g., 2016’s ‘Thin Ice’ said the global neoliberal architecture would crack once the US saw China as a hegemonic rival; or the surge in US investment being seen under the IRA, as noted in the press today– stressing this will continue; as will related arguments over redistribution; as will financial repression that keeps inflation higher than bond yields to reduce debts.

On Sunday, Yellen said credit tightening is de facto Fed rate hikes –not her job– and that “There is a risk when we use financial sanctions that are linked to the role of the dollar that over time it could undermine the hegemony of the dollar,” even if this is not “easy” to do. That kind of talk raises structural inflation risks, as do a flurry of related geopolitical developments:

• US regulators are focusing on hedge funds and shadow banking, following on from crypto.
• Germany shut its final three nuclear power plants despite energy tail risks ahead.
• A US intelligence leak says China secretly agreed to send Russia lethal aid, as a defence minister visit looms, and the Kyiv Independent says Chinese components are in Russian supplies. China would gain swift air superiority over Taiwan, according to the same source.
• China “advised” the Philippines to oppose Taiwan independence instead of offering the US access to its military facilities, if it wants to protect the 150,000 Filipinos working in Taiwan.
• Warren Buffet said he sold his shares in TSMC partly due to perceived risks of war, as BT, and other firms, are revealed to have “war gamed” China-Taiwan supply-chain disruptions.
• China refused to reschedule a visit from US Secretary of State Blinken, as a national security expert writes that Beijing does not want US ‘guard rails’, but a new staircase.
• Brazil’s President Lula, greeted in China with a local resistance song against the 1980s US-backed military dictatorship, called for a Sino-Brazilian partnership to “balance world politics,” asking: “Who was it that decided that the dollar was the currency after the disappearance of the gold standard? Why can’t we do trade based on our own currencies? Every night I ask myself why all countries have to base their trade on the dollar.” Even after President Macron’s recent comments, there is still political shock value (for the White House) in hearing Lula (whom the White House likes) being so anti-White House: not for many others.
• Stephen Roach says ‘the London crowd’ talked Cold War triangulation, China+Russia vs. the US, and: “the interest rate debate between Summers and Goodhart seemed mundane by comparison.”
• Israeli intelligence services fear a war with Iran within a year after recent probing attacks, as the Saudis host talks with Hamas, and Tehran works with China and Russia on arms supply.
• Sudan is seeing its army and a paramilitary force clash in the capital.

Summing it up, Larry Summers noted:

“There’s a growing acceptance of fragmentation, and –maybe even more troubling– I think there’s a growing sense that ours may not be the best fragment to be associated with…. Somebody from a developing country said to me, ‘what we get from China is an airport. What we get from the US is a lecture,’” and added that Middle East-Russia-China links are “a symbol of something that I think is a huge challenge for the US,” which is “looking a bit lonely on the right side of history, as those who seem much less on the right side of history are increasingly banding together in a whole range of structures…. If the Bretton Woods system is not delivering strongly around the world, there are going to be serious challenges and proposed alternatives.”

The BRICS are of course already free to dedollarise by reforming their economies and removing capital controls, and to denominate intra-BRICS trade in any FX: even CNY, as the PBOC tries to claim it’s now trading purely on market fundamentals – just open the capital account and see how much that’s true at present levels. Obviously the BRICS don’t or won’t for various reasons, which is why the dollar is still what it is globally. Former President Trump has recently stated the dollar losing global reserve status would be like the US losing a world war: but that’s only true if something else replaces it, and nothing can in the same way. (As Russia’s central bank is reportedly warning of CNH liquidity and hedging issues.)

Yet the BRICS –and Argentina, Indonesia, Iran, and Saudi Arabia– could try to net out their bilateral trade (e.g., X exports $50bn of goods to Y, Y exports $40bn to X, but they don’t use $90bn to settle, instead de facto bartering $40bn, so US dollar usage is just $10bn). For that group, this could mean a potential reduction of up to 650bn in USD usage vs. the almost $1 trillion total if all bilateral trade uses dollars. Throw in more EM, and you get an even larger drop.

And a larger mess. While BRICS could stop holding as many dollars, helping those looking at 5% or 5.25% rates to borrow them, it also means fewer recycled dollars to service US dollar debts. That smells like trouble in the Eurodollar system – and don’t expect US help if so.

Worse, within the global dollar system, the Anglosphere economies run a cumulative current account deficit of $1.2 trillion. That’s a physical trade imbalance paid for in USD or ‘team US’ FX. Whether you believe it’s driven by lazy Westerners or mercantilist EM, the capital account surplus still equals the current account deficit. To truly ‘dedollarise’ means to break those capital and goods flows together.

That is what will happen if more EM defensively barter/trade more with each other, and less with the West, which would get more supply-chain disruption and/or inflation until it builds new supply chains of its own – as with the US IRA, for example. At the very worst, this could even risk a retaliatory slide into a 1930’s-style global FX/clearing/trade bifurcation. Ooh Lula la, be careful what you wish for!

On which note, a Financial Times op-ed stresses that friendshoring –which the paper elsewhere underlines is inflationary, even if Yellen won’t say so, while urging the US to take a broader view of who its friends are– is a delusion. That’s because while low value-added processes are shifting out of China, the components assembled elsewhere still come from it before finished goods are shipped to the West. Indeed, recent trade data show Chinese imports remain depressed, but its exports are up hugely to non-US locations, who are exporting more to the US in turn. Yet the same voices were saying even this initial friend-shoring wouldn’t happen a few years ago. Indeed, the logic remains for decoupling happen across more components, with higher inflation.

Equally logical, China building trade surpluses with non-Western economies will see broader global trade pushbacks. Moreover, China building those new surpluses –with EM, they are now a third of those with DM, so rising sharply– could mean a runway is being foamed for breaking the global system in a scenario where breaking runways are considered.

Today’s lecture over – but are we looking at global ‘lectures & dollars’ vs. ‘airports & barter’? If so, volatility is likely to go far higher from here.