By Hema Senanayake –

Hema Senanayake

Mr. Trump who has been elected to be the next president of the United States has said that he would impose 100% import tax on BRICS countries if they continue their effort to dedollarize international trade and payment mechanism. This is a discussion now taking place in global financial capitals. It is quite normal because if President Trump continues with his “threat” there could be a huge mess in many economies which export to the United States. But it is not normal if a person with average intelligence who lives in a small village of Kahathuduwa, a few miles away from Colombo in Sri Lanka, nearly eight thousand miles away from New York, shows some visionary opinion on the subject. That led me to write this essay.

He opined that when he pays Sri Lankan rupees 140 to buy a loaf of bread, he knows that the bread has been valued by U.S. dollars and he is just paying the equivalent value in rupees. I was astonished, even non-economic lay individual has a realistic view on global payment mechanism. Unfortunately, leaders who utter rhetoric to dedollarize the international payment system might not have similar realistic view.

A former Chinese Central Bank governor said that it is a rare historical occurrence that the U.S. dollar which is a credit-based domestic currency of a country has become an international reserve currency facilitating international payments. Here the “credit-based domestic currency” has a unique meaning. It explains how dollars are created in the U.S. economy that facilitates local and international payments. Mostly, dollars are created when American banks loan out money to the government, businesses and households. Hence, such money created by commercial banks is known as “credit money.” And there is no printing of money or minting coins when money is created as credit-money. It is such money that the governor of Chinese central bank defined as “credit-based domestic currency”. This money has now become an international reserve currency. It is true that this is a rare historical event. But the U.S. dollar ensures the flexibility and stability of the international payment system. Moreover, as the person lives in Kahathuduwa of Sri Lanka explains, the U.S. dollar has become the unit of measurement of value so as to reveal the relative value of each product globally in order to exchange in the marketplace locally or internationally. This is fascinating.

If BRICS countries want to launch a new reserve currency, then they must first provide a unit of measurement of value that freely and flexibly penetrate into any product so as to reveal its relative value, facilitating the exchange of that product domestically and internationally. The determination of value and making a payment are two different things. Even currencies of BRICS countries get their relative value in relation to the U.S. dollar. Chinese Yuan or Renminbi, Russian Ruble or even Brazilian Real always reveal their value in compared to U.S. dollar. If Russian ruble depreciates against U.S. dollar and then such depreciation is reflected in Chinese renminbi so as to make payments for Russian imports. This is a thing that the U.S. monetary authorities have to understand and advise the president accordingly.

The U.S. has a unique situation. The U.S. is not getting its relative power to its currency due to any political or military might. Instead, its ability to tolerate a huge trade deficit is also a rare historical event. It is from this ability that the U.S. gets its power to its currency enabling other countries to save U.S. dollars. Usually, when a country faces a huge trade deficit, the textbook approach is to raise interest rates in order to discourage imports. This strategy does not work for the United States. When the U.S. Federal Reserve tries to increase interest rate, the global savings flow into the United States’ capital market to take the advantage of increased rate of interest. As a result, the increased rates cannot prevail for a long time. However, this facilitates for the U.S. to tolerate huge trade deficits enabling a significant number of countries to export to the U.S. market. In turn such exports facilitate the expansion of  those countries’ domestic markets too. All of these will collapse or will have significant negative impacts, if the U.S. increases tariff 100% for BRICS countries. Also, there will be a reciprocal damage to the United States’ dollar due to possible reduction of trade deficit and its ability to tolerate trade deficit via capital inflows. Therefore, the U.S. strategy to prevent dedollarrization by BRICS countries is not to take any legislative measure to reduce imports from those countries, instead ensure balancing of huge trade deficit via capital inflows which none of the BRICS countries are not ready or capable of doing it. Until BRICS countries increase their capability to tolerate huge trade deficit, launching a global reserve currency will be just wishful thinking.

Therefore, President Trump should not be panicked about the BRICS countries’ effort to dedolarrization, instead he must consider dollar as an international financial asset rather than considering it as the currency of the U.S. and avoid weaponizing it, in order to take monetary measures to strengthen the dollar, instead of import controls by imposing new tariffs on BRICS countries.