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Are BRIC Countries a Threat to the Dollar Standard?

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During the first BRIC summit last year, leaders from Brazil, Russia, India, and China discussed ways to conduct trade among themselves without using the U.S. dollar as a reserve currency. Russian President Dmitry Medvedev went so far as to unveil a new "world currency" coin at the G-8 meeting the following month to replace the dollar.

At their second summit, held last month in Brazil, the BRIC countries acknowledged improvement in the world economy, but also noted the need for big changes. Finance and banking officials in the countries continue to look into regional monetary and trade arrangements.

Could the BRIC countries threaten the dollar standard that the world has been operating on for decades?

Why the dollar rules (for now)
The United States has a bigger economy than any other single country. Using GDP figures based on purchasing power parity (PPP), the CIA's World Factbook puts the U.S. at $14.26 trillion, well ahead of China's $8.79 trillion. Although the European Union comes in slightly larger, at $14.51 trillion, the well-documented unraveling of Greece has put a lot of pressure on the euro as an alternative to the dollar. Given the euro's recent slide, the market clearly has more confidence in the dollar than the euro at present.

When you combine all four BRIC economies, they also weigh in larger than the U.S., at $16.49 trillion on a PPP basis. However, the BRIC countries don't all have completely free-floating currencies. Using current exchange rates rather than the PPP method, all four nations have lower figures that add up to just $8.64 trillion. But the group has seen rapid growth in recent years.

At both last year's and this year's BRIC summits, the idea of trade agreements permitting trade in local currencies has been discussed. That way, for instance, Brazil can buy Chinese goods in yuan, and China can buy Brazilian commodities in reais. Already, the People's Bank of China has started to set up bilateral currency swap lines with Argentina, Belarus, Hong Kong, Indonesia, Malaysia, and South Korea, in order to facilitate yuan-based trade.

This is all a good start, but as long as China keeps its currency pegged to the U.S. dollar, it won't make a huge difference. Only once the Chinese currency is allowed to float freely and the Chinese remove numerous capital controls will the yuan become a threat to the dollar standard.

One key reason why a dollar reserve currency standard has been easy to maintain is that the U.S. offers the deepest and most liquid capital markets in the world. If you accept payment in dollars, you can recycle them in a variety of dollar-denominated assets. In contrast, the governments that offer euro-denominated sovereign bonds have wildly divergent characteristics, making them anything but fungible. This is why the euro has little chance to replace the dollar as a reserve currency. The yuan does have a chance, but we are likely years away.

Who wins from a BRIC reserve currency?
Eventually, though, I expect the yuan to become fully convertible into other currencies. When that happens, the problematic currencies of the West are likely to experience notable declines against the current BRIC currencies. The main beneficiary will be gold bullion, which has steadfastly refused to decline despite the dollar's recent rally, and has been making all-time highs in euro terms. Assets dominated in BRIC currencies will also get a boost in value.

The easiest way to play the rise of BRIC currencies is through gold exposure, via the SPDR Gold Shares ETF (NYSE: GLD  ) . Western currency holders are likely to reach for gold -- the European interest in gold bullion at present is a good indication.

The Market Vectors Gold Miners ETF (NYSE: GDX  ) and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ  ) are also likely to do well in a rising gold price environment, along with the many gold stocks that have lagged the overall sector in the past five years. As a reminder, small-cap gold stocks are a lot more volatile than the large-cap ones, so even though an exchange-traded fund that holds small-cap names may give you better returns, you may also have to deal with bigger bumps along the way.

Stronger currencies should also boost equity investments in the BRIC countries. Single-country ETFs are available for all four countries. The iShares MSCI Brazil ETF (NYSE: EWZ  ) gives you access to many popular Brazilian stocks. The Market Vectors Brazil Small Cap ETF (NYSE: BRF  ) focuses on smaller names that generally aren't available via American depositary receipts on U.S. exchanges. Similarly, you can buy Russian shares via the Market Vectors Russia ETF (NYSE: RSX  ) , while mainland Chinese companies listed either in Hong Kong or the U.S. are accessible via the iShares FTSE/Xinhua China 25 ETF (NYSE: FXI  ) . PowerShares India Portfolio ETF (NYSE: PIN  ) provides similar exposure to India.

I predict that in the next 10 years, an evenly distributed basket of BRIC ETFs will triple the returns of the S&P 500, due to BRIC currency appreciation and stronger economic growth. With the S&P 500 essentially having gone nowhere over the past decade because of economic problems that are yet to be resolved, I don't believe that is going out on a limb.

Where do you think the BRIC countries are headed? Tell us what you think in the comments section below.

More on the dollar:

Fool contributor Ivan Martchev does not own shares in any of the companies in this story. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy. 

Read/Post Comments (2) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 10, 2010, at 3:49 PM, kingofthepaupers wrote:

    Ivan Martchev: "Are BRIC Countries a Threat to the Dollar Standard?"

    Jct: You can bet when the four of the biggest countries in the world start benefiting from using their own chips to do trade, the others will want to start using their own chips to do trade too and they'll all gravitate to the UNILETS Time Standard of Money in order to handle hundreds of databases.

  • Report this Comment On May 10, 2010, at 5:50 PM, ChrisBern wrote:

    I concur with the author that an evenly-distributed BRIC basket will trounce the S&P 500 (or a Europe-specific ETF) over the next 10 years, and even beyond. BRIC will not only win on currency during that time, but also on growth and profitability. Betting on America right now might look something like betting on the U.K on the first half of the 20th century.

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