Two big international gatherings took place last week. The one that was held in the Rocky Mountain resort of Jackson Hole was a demonstration of the grip the US has on the global economy. The one that was held in Johannesburg was evidence of the challenge posed to America from the leading emerging market countries.
Let’s start with Jackson Hole, where Jerome Powell took centre stage. What the head of America’s central bank had to say about interest rates clearly mattered for the US, where the economy has so far emerged relatively unscathed from the severest tightening of policy in four decades. The message was that the battle against inflation was not over and further increases in interest rates were possible.
But, by virtue of the dollar’s position as the world’s principal reserve currency, what Powell and his colleagues at the Federal Reserve do in the coming months affects life well beyond America’s shores. Commodities such as oil are priced in dollars. Countries that borrow in dollars can see their repayments soar if the US currency rises in value. Countries that run current-account surpluses use the proceeds to buy US Treasury bonds, enabling the US to run massive trade and budget deficits.
There is nothing new in this. It is the way the international financial system has operated since the second world war. Unsurprisingly, Washington wants the status quo to continue because it allows the US to fund its twin deficits without needing to take the tough deflationary action that would be demanded of less privileged countries.
Equally unsurprisingly, the US’s financial hegemony is not universally popular. One of the motivations for the creation of the euro was that a European single currency would be a rival reserve currency to the dollar. Last week’s gathering in Johannesburg of the Brics – Brazil, Russia, India, China and South Africa – was another attempt to mount a challenge to the US-dominated international order.
There are a number of reasons for this. Looked at from the perspective of a developing country, the way the global economy is run looks like a stitch-up. The US and its western allies have controlled the International Monetary Fund and the World Bank since they were founded in 1944, to the extent that every IMF managing director has been a European and every World Bank president an American. By virtue of their permanent seats on the UN security council, the US, Britain and France can veto any initiatives they don’t like. Between them, the US and the EU can prevent the leading developing nations exerting any real influence at the World Trade Organization.
What’s more, it is clear that this is not the unipolar world that policymakers in the US envisaged after the break-up of the Soviet Union. China has emerged as a genuine rival, and has been successfully expanding its sphere of influence. One illustration of this is a global map produced by the consultancy Capital Economics that divides the world into countries that are strongly aligned or lean towards either the US or China. Outside the rich, developed nations of North America, Europe, Japan and Australasia, there are few countries strongly aligned with the US, and the only emerging economies of note leaning towards Washington are India and Vietnam.
By contrast, most of Africa is seen as aligned or leaning towards China, as is most of Asia and a significant chunk of South America.
Is this that much of a shock? Not really. The Brics have their own bank, which, in contrast to the strict conditions demanded by the IMF and the World Bank, offers loans on a no-strings attached basis. The selfish behaviour of the G7 countries – the US, the UK, Germany, France, Italy, Japan and Canada – when they hoarded vaccines during the Covid-19 crisis was not exactly conducive to winning friends in the emerging world.
The shift in the geopolitical landscape was demonstrated by the countries invited to join the Brics club at last week’s summit: three were oil producers (Saudi Arabia, Iran and the UAE); two were from Africa (Egypt and Ethiopia) and one (Argentina) was from South America.
It would be unwise to read too much into the Brics expansion. There are tensions between China and India, and between Saudi Arabia and Iran, while South Africa is eager to maintain good relations with the west. Like the G7, the Brics summits are essentially talkfests, where little of substance is decided. Having 11 members rather than five increases the chances of disagreement. Talk of a common Brics currency is for the birds.
What’s more, it will take years – perhaps decades – for the Brics to create a financial infrastructure similar to that which supports the dollar. Crucially, investors would need to be as willing to hold bonds denominated in a non-dollar currency as they are to hold US Treasury bonds. The dollar’s dominance is not under immediate threat.
But that might not always been the case. Saudi Arabia’s decision to join the Brics also poses a threat to the dollar’s dominance. The oil-rich kingdom has traditionally been a reliable US ally in the Middle East but relations between Washington and Riyadh have recently cooled markedly. The expectation is that the Saudis will increasingly accept payment for oil from other Brics members in their own currencies.
The US Treasury secretary, Janet Yellen, has expressed concerns about the long-term consequences of using financial sanctions as a tool of American foreign policy, saying there was a risk “over time it could undermine the hegemony of the dollar”.
Yellen is right to be worried. A single, all-powerful reserve currency sits oddly with a multipolar world. It won’t happen overnight but a challenge to the dollar is coming.