Could This Emerging Financial Alliance Kill the U.S. Dollar?

A world-shaking event occurred this week in the global financial arena, and its impact will be felt for years to come. It will yank the wind straight out of the U.S. dollar’s sails and force a fundamental de-valuation of assets down to emerging-market levels.

Five leading nations — Brazil, Russia, India, China and South Africa — are starting their own financial system with a development bank funded exclusively by their nations.

They aim to establish an easy convertibility of currency (the real, ruble, rupee, renminbi and rand, respectively) and a focus on building long-term business relationships among themselves.

This isn’t just some emerging-market version of the euro zone. These up-and-coming economic leaders are opening the doors of opportunity for emerging-market companies that are positioned to challenge the global giants in their respective industries.

As an investor, you can’t afford to ignore this friendly meeting of the BRICS. (Note the fairly recent addition of the “S” with South Africa.) Here are three reasons why these countries are banking on a declining U.S. dollar and lessening U.S. influence … and why it may benefit you to do the same in the very near future!

Reason No. 1 : With this, the BRICS are set to assume
pole position in global financial governance.

BRICS nations represent nearly half the world’s population. Two of them are already among the top five economies in terms of purchasing power parity. (That is, an “exchange rate” of sorts as measured by the amount of money needed to buy the same goods/services in different countries). Four are in the top 10.

The plan strengthens financial cooperation among the BRICS’ development banks. This comes as leaders from Brazil, Russia, India, China and South Africa are seeking a bigger say in running the International Monetary Fund and other multilateral bodies to match their rising economic heft.

But these are not all investment-grade countries that can issue bonds to fund a new bank. One suggested solution is to dedicate a proportion of BRICS members’ foreign reserves to a trust fund that would back-stop the borrowed capital.

In the case of the World Bank, the total paid-up capital is around 10% while the rest is AAA-rated, “callable” capital. To enhance the creditworthiness further, existing multilateral banks and other Western countries could also be given minority stakes.

If you consider that these five countries now hold over $4 trillion in foreign currency reserves, the creation of this type of bank could mean some very serious contributions of capital. And this is clearly going to make these fast-growing countries, well, grow even faster!

Already, The IMF projects 2012 economic growth at 3% in Brazil; 3.3% in Russia; 7% in India; 8.2% in China; and 2.5% in South Africa. In contrast, the U.S. growth this year will be 1.8% while the 17-nation euro area will shrink by 0.5%, according to the IMF estimates released last month.

And trading in local currencies will strike a blow at the U.S. dollar and euro as a reserve currency, increasing the role of China’s, Brazil’s India’s and even Russia’s currencies relative to the U.S. dollar and the euro. This in turn would make it even easier for these countries to sign more-favorable transactions with other parties that would have normally demanded dollars.

Reason No. 2 : This will also have
real production and political effects.

Don’t assume this is just trade finance for only agricultural and natural-resource products.

Brazil will make a special effort to show that the country’s economy is more than just commodities and raw materials. Some of the businessmen traveling with the president will be from cutting-edge technology corporations.

Reuters is indicating that Brazil may be about to choose France’s Rafale fighter jet as the new aircraft for its military — at least a $4 billion deal from this emerging-market player that’s eager to become an economic superpower. If the deal goes through, it will come directly on the tails of India’s decision to buy 126 of the company’s warplanes.

Speaking of India, its relationship with the U.S. administration is better than ever before. However, there’s no guarantee that differences on some sensitive issue in the future won’t push the U.S. toward sanctions that could curtail this development or create other support issues. A conflict with Pakistan could be an example. Likewise, Brazil’s clear support for Cuba and Venezuela could at some point create similar problems if they selected the U.S. option.

More importantly, though, it’s extremely interesting that India and Brazil are discussing a military accord, since each country could complement each other in the industrial sector.

In addition to modernizing its fighter jet fleet, Brazil is seeking to obtain a transfer of software technology for the nuclear submarine that it is planning to build in partnership with France. And India officially rejoined the nuclear submarine operators’ club when the Russian manufacturers handed over to an Indian crew the Nerpa, in Russia’s Far East.

These and other proposed intra-BRICS initiatives like improving global governance will not only contribute to enhanced intra-BRICS trade and investments, but they would also facilitate growth in difficult economic times for these countries.

Reason No. 3: It’s no surprise — the winners are the top
emerging-market industrial and technology companies.

These developments and the new financial arrangement will create many new investment opportunities for investors that did not exist before AND strengthen some that are already available.

Keep in mind, though, that this financial alliance won’t be the easiest thing to implement. There will be points where these countries disagree.

For example, under intense pressure from the Russian government, India may consider working out a solution to grant some relief to Sistema Shyam TeleServices Ltd. According to official sources, SSTL’s case may be treated differently from others whose licenses were ordered to be canceled because it is the sole operator based on CDMA communication technology.

If you would like to follow these stories, I encourage you to take my Emerging Market Winners newsletter service for a risk-free test drive. As a member, you can easily follow the growing list of public companies that will benefit from this tectonic shift in focus and resources among the world’s fastest-growing emerging economies.

Best wishes,

Rudy