Three Signs We Are On Brink of New World Financial System

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Is it possible that we are witnessing the formation of a new international financial architecture? Three recent developments point in this direction:

First, there is the recent decision of the IMF to add the renminbi to the pool of the world’s reserve currencies.

Second, there was the announcement from Brazil, Russia, India, China, and South Africa, the “BRICS” nations, that they have formed their own development institution as an alternative to the IMF.

Third, China and Zimbabwe have recently announced that China is forgiving Zimbabwe’s debt coupled with Zimbabwe’s adoption of the yuan as one of that state’s legal currencies.

Are these three developments interrelated? Are they potentially significant?

Since 2009 China has been boldly calling for replacing the dollar as the world’s reserve currency with a basket of currencies. In the heat of the financial crisis of 2008 and its aftermath the United Nations Conference on Trade and Development (UNCTAD) called for significant changes in the world financial architecture. The full report that UNCTAD issued in 2009 has since been removed from the internet.

Over the past six years China has been quietly acting on its intentions by increasing its gold reserves to back up the yuan and by focusing on development of physical infrastructure at home and abroad, essentially shifting the global economic focus from an almost exclusively financial one (driven by derivatives and other speculative financial paper) to one that leans more heavily toward a physical economy based on development of large-scale infrastructure projects, including power plants and freight transportation systems.

It would be too early to assume that China and the BRICS development bank are panaceas for all emerging economies. It would also be an error to overlook the fact that Zimbabwe does not have a strong economy and that Robert Mugabe does not have a pristine human rights record which, in turn, could hurt his country’s prospects for development even without economic sanctions imposed externally.

With the three recent developments, however, it may be possible to glimpse what a new international financial architecture might look like and how international financial institutions might change the way they interact with emerging economies if these institutions want to remain relevant.

Any time a nation, such as Zimbabwe, takes another nation’s currency as its own, or keeps its own currency but pegs it to the value of another nation’s currency, then that nation is taking very desperate steps. To peg one’s currency to that of another nation, much less to adopt another nation’s currency altogether, greatly weakens the ability of the adopting nation to develop and implement its own strategy for nation-building and economic development.

Still, given the severe and protracted economic crisis in Zimbabwe, it doesn’t seem unreasonable that Zimbabwe might be better off with debt-forgiveness from China, coupled with Chinese investment in large-scale infrastructure to increase Zimbabwe’s productive capacity even as Zimbabwe adopts the yuan as one of its legal currencies.

Now that the renminbi is one of the world’s reserve currencies, and is also part of the BRICS development bank, this means that nations such as Zimbabwe — depending on the long-term deals they are able to work out with any of the partners in the BRICS development bank — might have greater access to world reserve currencies where they did not have as easy access before.

While Zimbabweans may continue to use US dollars, along with other currencies, to exchange goods and services on the streets, the government’s move to include use of the yuan as a legitimate currency, along with China’s role as Zimbabwe’s largest trading partner, is likely to feel its effects in terms of which currency Zimbabwe’s banks will hold in reserve, and what leverage that might give Zimbabwe in terms of global trade and in their dealings with global financial institutions. It will also be harder for Western powers to isolate and strangle Zimbabwe’s economy in order to punish Mugabe.

China is forgiving $40 million in Zimbabwe’s debts, which still leaves Zimbabwe heavily indebted to other nations, but this is a start and it may be an example of the possibilities for other creditors in relation to emerging economies beyond Zimbabwe.

Many Westerners are critical of Chinese investment in Africa and of the corruption of many African heads of state.  The critics might consider, however, what the West might learn from the Chinese model of aid and development. The Chinese model has focused heavily on building hard infrastructure, which is not so easily stolen, as opposed to aid in currency, which miraculously ends up back in Western banks, deposited by the recipients of such aid in their private and personal bank accounts.

Chinese investment in Africa and the BRICS development bank are not panaceas for the world’s emerging economies. Nonetheless, it would be foolish to overlook how the international financial architecture is gradually changing, and how this may lead to new models for the development of emerging economies.

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