Will Brazil and China abandon the dollar?

In March 2009, Premier Wen Jiabao made an astonishing announcement when he expressed his deep worries about the safety of China’s assets in the United States. In the financial world, most specialists understood that Beijing was growing increasingly concerned about holding nearly $2 trillion, with more than half of those holdings, estimated to be United States Treasuries and other dollar-denominated bonds. But what was unprecedented was for Mr. Jiabao to publicly declare his concern about the safety of those assets. Apparently his concern stemmed from President Obama’s huge economic stimulus plans that he believed could lead to soaring deficits in the United States, sinking the dollar’s value. After these remarks, the head of China’s central bank called for the creation of a new international currency reserve to replace the dollar. Zhou Xiaochuan, governor of the People’s Bank of China, said a new currency reserve system controlled by the International Monetary Fund could prove more stable, economically viable and necessary, because the global economic crisis has revealed the "inherent vulnerabilities and systemic risks in the existing international monetary system." The central idea is to create a reserve currency "that is disconnected from individual nations." [1] 

Even though many analysts agree that the dollar won’t be replaced in the short run, it is a notion that has been raised by other nations such as Russia and more recently Brazil, the fifth largest country in the world-after Russia, Canada, China and the United States and the third largest in the Americas. It is also a sign that former U.S. friends might be rethinking their alliances in times when the United States is losing ground in Latin America due to the financial crisis and the emergence of leftist leaders that seem prone to engage in partnerships with similar political actors.

Many nations in Latin America have grown increasingly weary of the United States’ seemingly double standards when dealing with its Latin American neighbors. Countries that have openly embraced U.S. values like Colombia find themselves at odds when Congress decides to stall a much needed free trade agreement. More so, any deal with the United States requires compliance in many aspects such as human rights and the environment, which in most cases are politically motivated. Not only that but trade deals and U.S. assistance requires legislative approval, which can be delayed for months and even years and which can be reversed at any moment. In response, many leaders such as President Lula da Silva from Brazil, Alan Garcia from Peru and Michelle Bachelet from Chile have decided to open their doors to China which seems more focused on a good deal and where the decisions are made by a single party, which can translate into more immediate results. Many Latin American presidents and business leaders also know that by engaging the Chinese, they will be better positioned to deal with the United States.

Brazil is an extremely important country for the United States and recently has positioned itself as a leader in the region. Even though most analysts feared that President Lula from the Workers’ Party would lead his country towards socialism, the Brazilian leader has been able to moderate his positions, adopting market friendly economic policies. He has also been able to manage his country’s relationships with Hugo Chavez from Venezuela as well as with Presidents Bush and Obama from the United States.  Impatient with the American backing of what he views as conservative and right wing governments, Lula wants to replace the hegemony of the United States in the region and wants Brazil to occupy that position, instead. In 2008, Brazil granted loans to Ecuador, sent peacekeepers to Haiti, lead negotiations between Chile and Bolivia to give the latter access to the Pacific, and offered to help the Bolivian government with anti-drug efforts after President Evo Morales kicked out the U.S. Drug Enforcement Administration last year.

Brazil is the largest national economy in Latin America, the world’s tenth largest economy at market exchange rates and is big in agriculture, mining, manufacturing and service sectors. The country has been expanding its presence in international financial and commodities markets, and is regarded as one of the group of four emerging economies called BRIC (acronym referring to "fast growing developing countries" of Brazil, Russia, India and China).

Trade between Brazil and China

In April 2009, China became Brazil’s most-important trading partner, relegating the United States to second place for the first time since the 1930s. Welber Barral, the Brazilian trade minister, said total trade between Brazil and China had amounted to $3.2 billion in April, representing a near twelve-fold increase since 2001 due to a sudden surge in Chinese demand for Brazilian iron ore in the first quarter of this year. [2]

China continues to buy large amounts of raw materials for its growing population and industry and has found in Brazil a perfect partner since it produces commodities like iron ore, soybeans and petroleum. China, a huge steel producer, is in need of huge amounts of iron ore and that helps explain the surge in trade between these two countries.

Brazil and China have also agreed to further oil and gas deals. In fact, Brazil is seeking investors to help explore the Santos Basin, significant in oil fields, which will be very expensive to extract. But China needs all the oil it can get its hands on and can afford this venture.

Relations between Brazil and China

Significant economic relations between these two nations did not begin until 1990, whenChinese President Yang Shangkun visited Latin America signing various treaties of cooperation and trade. From then on, these two countries engaged in high-level missions and now consider each other strategic partners.

As early as 1999, Brazil and China began collaborating on spy satellite technology, providing rocket launch expertise in exchange for digital optical technology that would permit high resolution, real time imaging. In fact, access to Brazil’s space tracking facilities could give China the ability to attack U.S. satellites with a variety of technologies currently under development. [3]

The ties between these two nations intensified after November of 2004 when Chinese President Hu Jintao visited Argentina, Brazil, Chile and Cuba signing 39 bilateral agreements and announcing $100 billion in investments by 2010, mainly in infrastructure. The PRC understands that many Latin American nations have the natural resources but lack the technological means to extract and transport these raw materials. Such investments serve as a guarantee that these nations will continue to supply commodities to the Asian superpower, opening the door for increased operations and presence in diverse sectors of their economies.

In November 2008, the Chinese Vice President Xi Jinping, second in command to President Hu Jintao visited Costa Rica, Cuba and Peru. Then in March 2009, Mr. Jinping together with Vice Premier for agriculture, Hui Liangyu, visited nine Latin American countries including Brazil, Mexico, Venezuela, Ecuador and Colombia.

In May of this year, Communist Party Chairman Jia Qinglin traveled to Colombia, Mexico, Uruguay, and Cuba and during that same month, Brazilian President Inacio Lula da Silva flew to Beijing for a three-day visit. During this trip, China and Brazil signed several economic deals to strengthen the ties between these two nations.  The most important deal was a $10 billion loan from the Chinese government to Brazil’s oil Company, Petrobras, to increase oil production.  In exchange, Brazil will send 200,000 barrels of oil a day to Sinopec, China’s state oil company, for the next ten years. The Chinese Development Bank agreed to loan another $20 billion to be used for a five-year $175 billion investment venture by Sinopec to extract oil and gas reserves off Brazil’s southern coast. The two oil corporations also signed a memorandum of understanding on exploration and the supply of equipment and services. Lula and Hu also agreed to launch two new satellites together.

During Lula’s visit, China agreed to diversify the products they buy from Brazil agreeing to lift restrictions on imports of chicken, beef and pork. Brazil, for its part, invited China to participate in improving Brazil’s railways in order to enable a rail link in the Pacific to reduce transportation costs of iron ore and soybeans.

Importance of Latin America for China

China needs raw materials for its rapidly expanding economy and industry. On the other hand, it needs trade partners that can purchase its electronics, apparel, toys, and footwear. Brazil could serve both purposes since it has a huge population (approximately 192 million people) and is abundant in raw materials, especially the kind China needs.

China’s trade with Latin America has grown ten times over the past decade, with exports destined for Beijing rising in value from $3.8 billion in 2000 to $36.1 billion in 2007. China now receives 4.7% of Latin America’s exports, up from 1.1% in the year 2000. Chinese figures indicate that total trade had reached $102.57 billion in 2007. [4]

In recent years, China has been signing Free Trade Agreements with several Latin American nations, including Chile, Peru and soon Costa Rica.

As a sign of things to come, China is not only openly increasing its presence in the US’ sphere of influence in Latin America. In fact, the biggest Brazilian project announced by the Chinese, a joint venture of Baosteel Group Corp. and VALE to build a U$3.6 billion steel plant, was canceled in January. A Brazilian representative revealed that Beijing has made Africa their priority, and that they expect to have a bigger political influence in that region than in Brazil. [5]

China and Brazil on the world stage

Besides being a nuclear-armed nation, China is a member of the U.N. Security Council, the World Trade Organization, the Group of 77 developing nations, and the Asia Pacific Economic Cooperation group. In addition, it also holds observer status in the Organization of American States. Brazil and China both have sought an increasing role at the IMF as well. In fact, it was the Brazilian finance minister that called for emerging economies to be integrated into the financial stability forum (FSF) a process that is ongoing. Both are key members of the G20, which is now the key institution for responding to the financial crisis. [6]

The Taiwan Issue

China’s main rival for global preeminence is the United States. China sees the United States as preventing Taiwan’s reunification with the mainland as well as in competition for needed natural resources. In response, China now challenges U.S. influence wherever it can, especially in Latin America.

Dump the dollar?

The idea of replacing the dollar as the international currency arose at the World Economic Forum in Davos, Switzerland, on January 28, 2009 when China’s Prime Minister Wen Jiabao blamed the United States for the economic crisis the world is now experiencing. He talked in particular of "the failure of financial supervision". [7]

A month later, Brazilian President Inacio Lula da Silva and President Hu Jintao, in fact, discussed the idea of replacing the dollar with the Renminbi (RMB) and the Real as trade currencies when they met at the G20 summit in London.

Last month representatives of the two governments announced that the governors of the two countries’ central banks would meet soon to discuss replacing the US dollar with the Renminbi and the Real in trade transactions. Brazil has already signed an agreement in September with Argentina under which importers and exporters in the two countries may make economic transactions payments in Pesos, Reals or dollars.

In a recent interview, Lula furthered this notion by saying: "Between Brazil and China, we need to establish a trade that is paid for in our own currencies. We don’t need dollars. Why do two important countries like China and Brazil have to use the dollar as a reference, instead of our own currencies? We’ve already started doing this with Argentina. Our trade is taking place in our own currencies. Otherwise, we’ll be in an absurd situation, where the country that caused this crisis will be the country that gets the most dollars. It’s crazy that the dollar is the reference, and that you give a single country the power to print that currency. We need to give greater value to the Chinese and Brazilian currencies." [8]

Even though dumping the dollar will not happen any time soon, the announcements made by such power players as China and Brazil should be taken as an indication that they are looking away from the dollar and the United States, that the U.S. is rapidly losing its influence in Latin America and that the PRC is now a major competitor in the region.

Given the current situation, it is imperative for the Obama Administration to recognize this new reality and to have a more engaging approach to its Latin American neighbors by signing and ratifying any outstanding Free Trade Agreements, especially with Colombia. Not only is this important in economic terms but it is critical as a sign that aligning with the United States pays and that Washington honors its commitments. The U.S. should also stop its protectionist policies such as tariffs and engage Latin American countries as partners. It also has to continue promoting democracy and the respect for the rule of law in as many countries as possible. The Obama Administration should also reduce unproductive restrictions on assistance projects to its neighbors, in addition to pressing harder and aiding in economic reforms. Brazil is a very important player and if it decides to fully embrace the Chinese to the detriment of the United States, other nations could follow suit.

Nicole M. Ferrand is a research analyst and editor of "The Americas Report" of the Menges Hemispheric Security Project. She is a graduate of Columbia University in Economics and Political Science with a background in Law from Peruvian University, UNIFE and in Corporate Finance from Georgetown University.

NOTES

[1] Zhou Xiaochuan’s Statement on Reforming the International Monetary System. March 23, 2009. The Council of Foreign Relations.

[2] China overtakes the US as Brazil’s largest trading partner. May 9, 2009. The Telegraph.

[3] Balancing China’s Growing Influence in Latin America. October 24, 2005. The Heritage Foundation.

[4] China’s Latest Geopolitical Assault on Latin American Commodities and Bilateral Trade. February 17, 2009. Council of Hemispheric Affairs.

[5] Brazil and China: Moves Towards a New Economic Order? May 19, 2009. RGE.

[6] Ibid.

[7] China’s latest geopolitical assault on Latin American commodities and bilateral trade. Ibid.

[8] RGE – Ibid.