Upgrading Bretton Woods: A Case for “Currency Baskets” – Modern Diplomacy

In recent years, shortages and insecurities have increasingly afflicted the global economy as it was grappling with issues such as supply-side disruptions, energy shortages and food security concerns. In the field of international finance, the world’s central banks had their fair share of risks, with one of the key shortages being the sore lack of reserve currencies coupled with few diversification options in allocating currency reserves. These concerns were magnified in 2022 after the escalation of geopolitical risks and the imposition of sanctions on Russia’s reserve assets in the hundreds of billions of dollars.
Such developments put into question the security of the dollar-centered international monetary system, rekindling discussions on the prospects of new reserve currencies such as the BRICS reserve currency. The new entrants in the international currency reserve space that are likely to emerge may include not only national reserve currencies but also currency baskets. If successful, these new entrants can transform the global monetary system towards greater optionality and lower exposure to geopolitical risks.
Among the new entrants in the reserve currency space is China’s yuan, a national reserve currency that has—slowly but surely—been taking a greater share of currency reserves and transactions in the global economy. Just like the dollar and any other national currency, however, the yuan may be susceptible to country-specific vulnerabilities, sanctions and swings in geopolitical risks.
Thus far, an expansion in the pool of reserve currencies composed of national currencies has progressed very slowly, raising the question of whether any significant change in the monetary system is possible, given the sole focus on national reserve currencies. Hence discussions revolving around a BRICS reserve currency as a currency basket that brings together the currencies of India, Russia, Brazil, China and South Africa.
The proposal to create a new reserve currency based on a basket of BRICS currencies was first formulated by the Valdai Club in 2018. The idea was to create an SDR-type currency basket composed of the BRICS’s five national currencies, potentially involving some of the other currencies in the BRICS+ circle economies. The choice of the composition of the BRICS currency basket had to do with the fact that these were among the most liquid currencies across emerging markets. The name for the new reserve currency — R5 or R5+ — stemmed from the first letters of the BRICS currencies, all of which begin with an R (the real, the ruble, the rupee, the renminbi, and the rand).
The new BRICS reserve currency basket could act in concert with the stronger role performed by BRICS national currencies to take on a greater share of the total pie of currency transactions in the world economy.
There are a number of advantages exercised by currency baskets such as the proposed BRICS reserve currency. First, there is the reduction in the dependency/exposure to any single country risk, with cross-regional currency baskets reducing the exposure to risks pertaining to any single region. Second, there is the reduction in the risks associated with the high volatility of any single Global South currency, as the platform that brings together currencies from economies with divergent trade profiles and varying exposure to shocks will result in a lower volatility of the currency basket as such. For the Global South, a basket mechanism for the new reserve currency could serve as an incubator of new national reserve currencies. In the case of the BRICS reserve currency, the advanced status of the Chinese yuan could be used to prop up the status and the potential reserve role for the currencies of other BRICS (or BRICS+) nations.
The emergence of new currencies as well as greater use of more national currencies or baskets of national currencies could also reduce the costs resulting from an excessive dollarization of the world economy. Existing research points to significant costs sustained by the countries with relatively high levels of dollarization, with one such study noting that “the presence in residents’ portfolio of foreign-currency assets and liabilities (or ‘financial dollarization’) has been alleged to influence monetary policy in developing economies and, especially, to cause debtors’ insolvency in the aftermath exchange rate depreciations (the ‘balance sheet effect’)… [Furthermore,] financially dollarized economies display a more unstable demand for money, a greater propensity to suffer banking crises after a depreciation of the local currency, and slower and more volatile output growth, without significant gains in terms of domestic financial depth. The results indicate that active de-dollarization policies may be advisable for the many economies.”
Most importantly, in a world of sharply higher geopolitical risks, a currency basket mechanism becomes one of the better instruments (compared to national currencies) in reducing the exposure to geopolitical risks and economic restrictions emanating from any one single country or region. The reduction of geopolitical risks will be the more significant, the more geopolitical heterogeneity there is in the currency basket. In this respect, a BRICS reserve currency is quite balanced as it brings together differing countries such as China and Russia on the one hand (with significant geopolitical competition with the West) and countries such as Brazil and India on the other (significantly more cooperative relations with the West).
For the new currencies to be more competitive on the international stage compared to the “incumbent currencies” such as the U.S. dollar, the new entrants need to carry a legal affirmation of the non-use of such currencies in sanctions or restrictive measures. Such a de-politicization of new currencies would render them significantly more attractive for the Central Banks in the midst of elevated geopolitical risks. A non-sanctions/depoliticization clause could be included into the charter/norms governing the new reserve currency. In the case of regional currencies, this may be undertaken by the respective regional financing arrangements (RFAs), while in the case of cross-regional projects such as the BRICS reserve currency such norms should come from the BRICS Contingent Reserve Arrangement (BRICS CRA).
Therefore, the existing global currency represented by a currency basket—Special Drawing Rights (SDR)—has the potential to significantly expand its presence in global currency reserves and currency transactions. It has the benefit of bringing together the most liquid currencies in the world, with the heterogeneity of the basket attained via the inclusion of the four currencies from the advanced economies (USD, Euro, Japanese Yen and the UK’s Pound Sterling) as well as the Chinese yuan. The IMF, as the regulator of the SDR, could potentially enhance its role in the global economy through allowing its use in international trade transactions as well as raising its attractiveness as an instrument of currency reserve holdings for the world’s central banks. According to a prominent American economist Maurice Obstfeld, “denominating more global reserves in SDR would affect exchange rate volatility among the main reserve currencies primarily to the extent that it reduced potential official demand shifts among those currencies. Were more countries to peg to the SDR as a result, however, their effective nominal (and probably real) exchange rate volatility would fall”.
The IMF itself points to tangible advantages in the greater use of SDRs in the global economy, including with respect to lowering the volatility of financial market instruments: “M-SDRs [SDR-denominated financial market instruments] reduce foreign exchange and interest rate risk relative to single-currency instruments, but there are some drawbacks and challenges. The basket nature of M-SDRs would allow the volatility of returns to be lower than for a similar single currency instrument”.
Similarly, the establishment of a BRICS reserve currency could well reduce the volatility in the EM currency space, including via the issuance of financial instruments with lower volatility of returns. The R5 could also serve as an important benchmark for other parts of EM—rather than pegging to the U.S. dollar or the SDR, BRICS’s regional partners as well as other EM economies could peg their currencies to the BRICS currency basket. The projects of new regional currencies currently entertained by the regional blocks in the developing world (Latin America being one case in point in line with the statements of Brazil’s president Lula da Silva) could potentially be pursued on the basis of a basket mechanism and/or with the possibility of pegging the new currency to the BRICS basket.
The bottom line is that we are only at the start of what may turn out to be an emphatic expansion in the array of reserve currencies with currency baskets being potentially among the most competitive and flexible instruments in the global economy. Such currency baskets could well include new regional currencies, if and when they emerge, as well as cross-regional currency baskets. The variety of the combinatorics of such reserve currency platforms can significantly expand the optionality of reserve allocation for the world’s central banks. The future of the new international monetary system is paved with new reserve currencies.
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Often when we talk of ‘lifestyle’ in different parts of the world – including India – we end up restricting ourselves to European and western luxury brands. There is not an iota of doubt, that there is a growing demand for the same, and in the changing economic order India happens to be an important market for western luxury brands – be it watches, garments, handbags and shoes. At the same time, the middle and upper middle class is an important segment amongst Indian consumers. They make not necessarily make big ticket purchases – and instead invest that money elsewhere — they are interested in high quality products at affordable prices.
Here it would be pertinent to point out, that in recent times there is a strong trend of Japanese brands related to clothing, household accessories having become more popular in the Indian market. In one of Delhi’s top shopping malls — Ambience Mall, Vasant Kunj – Miniso(a Japanese brand known for affordable and high quality household accessories)   and Uniqlo (a famous Japanese ‘fast fashion’ retail brand) are located right next to each other. Brands like Uniqlo, Asics (a Japanese sportswear brand) along with home appliance stores like Miniso and Muji have been doing well outside the metropolitan cities as well.
 There is no doubt, that Japanese cars, gadgets and even watches (Seiko, Citizen) have been popular for very long due to their reputation in terms of quality, but the arrival of the ‘Grand Seiko’ series has made Japanese watches popular, even amongst consumers who for long preferred other luxury watch brands (both Seiko and citizen are affordable, have a stellar reputation in terms of not just technology and workmanship, but also design). Seeing the increasing success of Japanese watch brands mentioned above, there is scope for others too. For instance for anyone willing to spend in excess of $20,000, Naoya Hida could be a preferred choice.
Then there are brands like Minase (which has a wide range of options) and Kurono. For those wanting high quality watches in lesser prices, Kuoe based in Kyoto is an attractive option. Japanese watch makers in recent years have also got a better understanding of the global watch market and while focusing on technology, they have tried to come up with options which are no less in terms of aesthetics and finish – vis-à-vis their western counterparts. Given that the Indian consumer, including those interested in watches, are always looking at new alternatives the above watch brands have immense potential. Apart from this, Japanese watch makers which are yet to make their foray into India in a big way should focus on tier-2 and tier 3 cities given the immense economic potential and the willingness of consumers to spend. Some of the Japanese watch brands could do especially well in the North-East, where there is a growing middle class and an interest in East Asian products.
In conclusion, while Japanese brands have become popular in recent years with the Indian consumer, there is still immense potential for tapping the Indian market. Some of the Japanese watch brands, in addition to Seiko and Citizen, discussed earlier have immense potential. It is important for these brands to enter the Indian market since their designs and technology would be of interest to watch lovers in India. Many of the Japanese watch brands combine high quality with affordability unlike some of the western brands.
If real estate is anything to go by, Dubai is snubbing its nose at Saudi efforts to replace it as the Middle East’s go-to business and expatriate hub.
Saudi Arabia’s insistence that corporations doing government-related business in the country, many of which have their regional base in Dubai, move their offices to the kingdom by 2024 has yet to dampen the appetite for Emirati real estate.
Last week, the kingdom eased its rules by exempting companies that are sole bidders on a government contract and enterprises with annual foreign operations worth less than one million Saudi riyals ($266,000).
Similarly, big-ticket Saudi projects have so far failed to dent the Dubai real estate market.
Prominent among those projects is Neom, a US$500 billion futuristic, 25,000 square kilometre desert city on the Red Sea.
Saudi Crown Prince Mohammed bin Salman expects Neom, which seems more like a vignette in a science fiction novel than a real-world project, to become home to nine million people.
In addition, the new city s slated to host the Middle East’s first international winter sports tournament in 2029.
Neom takes a leaf out of Dubai’s marketing strategy that has successfully touted the Emirate’s projects in superlatives.
Conceived as a linear metropolis, the city in the making envisions creating 15 islands in its first phase alongside “a complete mobility system,” the “largest marina on Earth,” and a commitment to sustainable energy and turning 95 per cent of the city into a natural reserve.
If indeed built as envisioned in the mind-boggling plan for the city, Neom, a metropolis centred on The Line, a 34 square kilometre linear smart city, will run on 100 per cent renewable energy with no carbon emissions, have no roads or automobiles, and retain most of its area for wildlife thanks to its smaller infrastructural footprint.
Meanwhile, Dubai’s real estate market is soaring.
In October, Indian billionaire Mukesh Ambani bought 5,534 square metres of land priced at US$163.4 million on Palm Jumeirah, an artificial island populated by glitzy hotels and posh villas and apartment towers.
Mr. Ambani also acquired an US$80 million mansion for his youngest son.
Weeks later, a mystery buyer purchased an eight-bedroom, 18-bathroom villa on Palm Jumeirah for US$82.4 million.
A large influx of ultra-high-net-worth, often cash-paying individuals, many of them Russians, fuels real estate demand in Dubai that last year drove prices up by 70 per cent.
The freewheeling deals were one reason why the Financial Action Task Force (FATF), an anti-money laundering and terrorism finance watchdog, put the UAE on its grey list.
FATF has since said that as a result of reforms, UAE, keen to be seen as a transparent international financial hub and a model global citizen, had become “compliant” with 13 of its 40 recommendations, “largely compliant” with 23 recommendations and “partially compliant” with four.
Even so, Dubai appears to have no intention of publicizing its property registry. Critics assert authorities have little incentive to increase oversight or transparency because that would dampen interest at a moment when Saudi Arabia is seeking to unseat the Emirate, at least as far as corporates are concerned.
Moreover, discretion is one reason the Dubai real estate market goes from height to height at times of crisis, like the Ukraine war and the recent pandemic.
Beyond Russians, recent buyers include cash-rich Gulf nationals, Israelis, people leaving China since the easing of Covid-19 restrictions, and those shifting operations out of London in the wake of Britain’s exit from the European Union.
In a statement last year, the UAE said that it “takes its role in protecting the integrity of the global financial system extremely seriously. This includes embedding a clear regulatory framework for real estate brokers,” who are obliged to file reports to the government’s Financial Intelligence Unit for real estate purchase and sale transactions.
Nevertheless, the Dubai real estate market has witnessed its up and downs.
Many see the 2008/2009 crash as the fallout of the global financial crisis, even though research by major real estate companies predicted a downturn before and independent of the economic collapse.
Analysts caution that debt refinancing because of the rising cost of borrowing poses a threat in a market in which 19 per cent of banks’ credit-risk exposure is real estate-related.
Developers are less concerned.
“Do I worry about a tsunami or typhoon? Well, it’s like the pandemic, no one saw it coming, but it came. You can’t really worry about that,” said Murat Ayyildiz, chairman of Alpago Properties, a Dubai luxury property developer.
No one expected the speakership contest to stretch for 15 rounds before Republican Kevin McCarthy took reins of the House of Representatives. The Democratic supporters rejoiced at the GOP infighting that saw Mr. McCarthy plead his case with his own colleagues over four days of intense struggle to gain the support of 218 newly-elected lawmakers. However, now firmly settled and in control of the House, the Republican roster gears into full swing – from launching investigations into the Biden household to squeezing the Treasury department into subservience. Yet the glaring caveat is the anticipated brinkmanship over raising the federal debt limit.
According to a letter to Congress by Treasury Secretary Janet Yellen, the outstanding debt of the United States is “projected to reach statutory limit” on Thursday, Jan. 19, 2023. The threshold was raised to approximately $31.4 trillion on Dec. 16, 2021 – a measure that allowed the new US government to borrow to meet its fiscal obligations. The United States traditionally runs heavy budget deficits, funding Social Security programs, Medicare benefits, and military salaries, servicing the national debt, and managing tax refunds. Because the cumulative federal spending broadly exceeds the revenue brought in through taxes and other streams, the US government borrows extensively to foot the residual bill. 
Historically, the Republicans have attached steep spending cuts and other similar concessions to negotiate over the debt limit. In 2011, the congressional impasse over spending cuts and the debt ceiling was resolved just in time, followed by a brutal stasis that culminated after the then president Barack Obama conceded to the Republican lobby. Yet while the limit was never breached, the mere uncertainty rattled the financial markets. Investor and consumer confidence plummeted; the cost of borrowing for businesses spiraled due to a higher perceived risk of a sovereign default; the stock market plunged. For the first time in its history, the S&P Global Ratings downgraded America’s credit rating. A repeat of that episode – let alone an actual breach of the debt limit – would not only destabilize the already fragile US economy but could also tumble the global bond markets, which significantly bank on US Treasuries as a safe asset class. In September 2021, Moody’s Analytics cautioned that a default on Treasury bonds could throw the US economy into a tailspin “as bad as the Great Recession,” potentially leading to a 4% decline in Gross Domestic Product (GDP) and loss of circa 6 million jobs.
Prominent Republicans have criticized subsequent Democratic regimes over excessive spending and high borrowing cycles. In a discussion on Fox News last week, Mr. McCarthy termed the US debt as “one of the greatest threats” to the American nation, adding, “We don’t want to just have this runaway spending.” Other popular GOP lawmakers, including top Republican Sen. Mitch McConnell, have a notorious history of forcing fiscally conservative policies before voting for an increase to the debt ceiling. However, President Joe Biden has categorically refused to negotiate the debt limit by offering concessions on spending plans. Thus, a ruinous deadlock is all set to hit Congress by mid-April, the tax deadline that would shape a much better picture of the government finances and allow the Biden administration to negotiate from a relatively robust footing.
Nonetheless, the GOP lawmakers realize that the US economy is already on the cusp of a recession; any inane policy tussle could exacerbate the economic woes – making the job harder for the Federal Reserve to control inflation while preventing an extended period of economic pain and unbridled unemployment. Even Ms. Yellen – a fervent advocate of abolishing the borrowing cap altogether – has urged the bipartisan Congress to “act promptly to protect the full faith and credit of the United States,” writing further that “[A] failure to meet government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability.” Meanwhile, the Treasury is gearing up to implement two extraordinary measures to free up some fiscal space for a limited time.
While the congressional elements battle out the policy divide and negotiate the debt limit, the Treasury would (1) redeem existing, and suspend new, investments of the Civil Service Retirement and Disability Fund (CSRDF) and the Postal Service Retiree Health Benefits Fund (Postal Fund), and (2) suspend reinvestment of the Government Securities Investment Fund (G Fund) of the Federal Employees Retirement System Thrift Savings Plan. According to Ms. Yellen, these measures will “reduce the amount of outstanding debt subject to the limit,” allowing breathing space for the federal government to finance its operations till early June. Many economists expect a timely resolution before these emergency measures are exhausted. But a prolonged stalemate could lead to a squeeze in the social safety net and even a default on federal debt. Such extreme moves could lead to a wipeout of “the equivalent of one-tenth of American economic activity,” according to estimates by Goldman Sachs analysts. 
While I do endorse fiscal responsibility and debt control policies, it seems like an awfully perilous gamble, especially when the spending plans currently on the table have already been approved by the Congresses of both parties.
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