The currency conundrum for Bric countries

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: The dilemma that faces Bric economies today is about how to tailor their foreign exchange policy. Should they accord greater weight to capital inflows, welcome them but also risk inflation and higher real effective exchange rates (REERs)? Or, should they orchestrate policy to ward off inflows of that nature in order to maintain export competitiveness? These are the fundamental issues.

And these must actually be addressed amid the current context that comprises a volatile US dollar, a seemingly imperturbable Chinese yuan and outflows of US capital. The latter is fleeing Bernanke’s virtual zero interest rate regime, one that is central to his quantitative easing package (The Fed has lowered its benchmark rate to between 0.00% and 0.25%, pumped $2 trillion-plus into the financial system and directed banks to expand lending). Those actions have far-reaching implications precisely because 62% of the $7.3-trillion in forex reserves held by central banks and sovereign wealth funds (SWFs) currently are denominated in US dollars. Only 25% is in euros.

Yet, as recently as in September, World Bank chief Robert Zoellick did also caution the US against excessive smugness about the dollar’s pivotal status as reserve currency. He also identified the need for a ‘multiplicity of the global reserve currency’, seeing that as a part of the shifting focus of global growth in the post-crisis era (one in which US consumers can no longer be relied on to be the sole engine of demand). Indeed, his caution—that there ‘will be increasingly other options to the dollar’—is a forecast that appears to be more convincing by the day.

Even reality seems to point that way. No less than three of the four Bric economies have decided to extend free rein to market forces vis-à-vis the dollar—and the currencies of all three are appreciating. Accordingly, we saw on November 20 that the Brazilian real, Russian rouble and Indian rupee each were reported to be well above their median-July 2009 rates against the dollar (see table). And that applies also to the Japanese yen and South Korean won. Yet, the real story is not about currency appreciation, but why—and how—China is using the yuan to remote control the US economy.