A New Bank for the BRICS

As five leaders, representing nearly half of the world’s population, descended on the Brazilian city of Fortaleza to attend the sixth BRIC’s (Brazil, Russia, India, China and South Africa) Summit, scheduled for July 15-16, elaborate security measures were being put in place, street drains within proximity were meticulously inspected, local police had cordoned off the area to traffic and military jets prowled above the skies ensuring that the no fly zone within proximity of the Summit’s venue were observed. But it wasn’t the security activities around Fortaleza (Fortress) that grabbed the headline, but rather what was being discussed inside the Summit. 

As the leaders sat around a table, they were discussing the potential end of, what they perceived to be, the way mega business, aided and abetted by the US and its allies, had an unchallenged ability to exert a wielding influence over the world’s economy since the end of WWII. The International Monetary Fund (IMF) and the World Bank, both institutions established almost 60 years ago by the world’s most powerful nations in the aftermath of WWII, is increasingly being viewed by the group of BRICS nations as pretty much the facilitators for US and allied economic supremacy. While the World Banks and the IMF, both share the same aim of ending extreme poverty and boosting shared prosperity this seems less realistic today with rising inequality, even among developed nations. Moreover, these altruistic goals are perhaps a smokescreen for their true function, according to critics who believe that these financial institutions are merely tools of corporatocracy, a society or system governed by corporations. “When the IMF or World Bank lends money, strings are invariably attached, and those strings tend to reflect the values and interests of Washington and its allies,” said an analyst at the Institute for Development Studies in Sussex, UK.

So the BRICS plan, to resist a society ruled by big business and White House policies, is to launch its own development bank, called the BRICS bank and a monetary stabilization fund called the Contingent Reserve Arrangement (CRA). Indeed, adding flesh to the bones, BRICS nations were able to conclude at the Summit in Fortaleza the financing structure of the BRICS bank and CRA. Both BRICS financial institutions will rival the World Bank and the IMF and are scheduled to be launched at the conclusion of the Summit. The choice of city is expected to be made soon along with the leadership of the bank, which will be rotated every five years.

The CRA will have 100 billion, with China being the largest contributor of 41 billion USD; Brazil, India and Russia, with all contribute 18 billion USD each and South Africa will add 5 billion USD to the fund. The BRICS Development Bank will begin operation with a capital of 50 billion dollars with contributions of 10 billion and guarantees of 40 billion from each of its members. The BRICS Bank has ambitious expansionary plans. It intends to expand 100 billion dollars within two years, and up to 200 billion in five years. The Development Banks projected capacity for financing projects is anticipated to total 350 billion USD by 2019. This is certainly by no means small beer. 

Therefore, assuming the BRICS Development Bank and CRA are successful, it would be reasonable to assume that these newly formed financial institutions could then end the monopoly stranglehold that the IMF and the World Bank’s has over financing large scale international development projects. Additionally, for the economies involved in the architecture of BRICs financial institution, being able to circumvent the World Bank and the IMF for development aid and apply to their own group’s BRICS Development Bank may be a real boon. The BRICS economies might be able to benefit from the no strings attached financing of the group of countries new BRICS Development Bank. Previously, much World Bank development aid concerning hefty infrastructure projects in developing countries tended to be tied down to the approval of finance, which was subject to contracts being awarded to US and western corporations. Moreover, interest payments on the loans made also resulted in payment outflows from the BRICS economies. In view of this, it then becomes fairly apparent that the creation of BRICS Development Bank, in theory is likely to be a boost to BRICS companies, their bank and its economies. 

On the other hand, the implications for US and allied corporate titans may not be so favourable in so much as it could also extinguish an era of plum public contracts being awarded on a silver plate to these corporations. There might also be the added risk that the BRICS Development Bank could deliberately or by chance promote policies within BRICS nations and beyond that are at odds with those of the White House. So it’s reasonable to assume that the BRICS bank could act as a facilitator in the shifting of economic and political power from the West to the East.

However, the extent to which this power and political shift plays out depends on the BRICS Development Bank’s effectiveness as a means of financing infrastructure projects within the group’s countries and beyond. If the BRICS bank is just another replica based on the IMF and World Bank model, with its criticized shortcomings, then its influence may not be as significant as anticipated by its architects. Like any institution, it is run by human beings who often have self-serving interests, combine this with little transparency and practically no press freedom in a number of BRICS countries and it might just be the perfect cocktail for a few oligarchs becoming even more powerful at the cost of many. That would be worse than corporatocracy.

But that’s maybe just a cynical view, on the upside the BRICS Development Bank has maybe got the world’s financial architects thinking about the need for change. If that is the case, then let’s hope that what emerges is for the greater good.

Gold! Should You Have It In Your Portfolio?

 Having reached highs of $1923 in 2011 Gold has been drifting down ever since.  As gold is regarded as a safe haven investment and we continue to live in a very uncertain world why has it drifted off?

Gold is used to diversify risk in portfolios.  It produces no income but global investors will head for safe havens such as the US Dollar and gold when there is significant uncertainty to make investors nervous. It earns no interest but investors will buy it for stability when the value of other assets is falling or is not adequately compensating for risk.  So in a crisis or when inflation is undermining the value of investments portfolio managers will buy gold as a hedge.  This puts pressure on the price, and the ensuing increase in value of the investment, at least partly, offsets the losses elsewhere in the portfolio.

It has a major role in the thinking and financial planning of all global financial authorities so that in 1999 the Washington Agreement On Gold between Europe, The United States, Japan, Australia, Bank for International Settlements and the IMF agreed to limit gold sales to 500 tonnes per annum for 10 years. That has been extended beyond 2009 for a further five years to sales of no more than 400 tonnes.  During that first period the Bank of England and Swiss National Bank were keen sellers something they may have regretted during the financial crisis when gold rose rapidly in value. 75% of all the gold produced has been mined since 1910.  It is, generally, stored as gold ingots with one ingot weighing 400 troy ounces which is about 12.4 kilograms.

Gold has many uses in electronics, dentistry, medicine, radiation shielding and, of course, jewellery.  It is a highly malleable metal and extremely ductile so that one ounce of gold can be stretched into a gold thread 8 kilometres long.  It can even be used as embroidery thread. An ounce of gold can also be beaten into a sheet that is 300 square feet large and can be made so thin that it is transparent. It is odourless and tasteless, is non-toxic and can be digested as metal flakes in food or drink without ill effects.

The purity of gold is measured in karats and pure gold is 24 karats.  It is, however, very soft and can wear away very easily so in less pure forms it may contain a variety of other metals such as silver, copper and platinum in order to make it cheaper or tougher or to meet other criteria. Very few chemicals can attack gold so that it can be buried for many years without deteriorating.

Gold was first used as money in 643 BC.  The first time it was valued was by Emperor Augustus in ancient Rome when the price of a pound of gold was set as being worth 45 coins.

The price of gold is determined twice each day on the London bullion exchange by five members of the London Gold Market Fixing Ltd via a telephone conference facility.  Originally this took place in the offices of N M Rothschild & Sons just once a day at 10.30am, however in 1968 a second time of 3pm was established in order to coincide with trading in the US. The price is set in US dollars, Sterling and the Euro.

The first modern day gold price was set in 1919 at a price of US$19.39 per ounce or four pounds 18 shillings and 9 pence per troy ounce.

In 1933 the President of America at that time, Franklin D Roosevelt ordered US citizens to hand their gold over to the government for $20.67 per ounce and the price was promptly raised to $35.00 per ounce.

During the 2nd world war the fixing of the gold price was suspended in 1939 and not resumed until 1954. In 1946 The Bretton Woods System was enacted whereby the 44 countries that joined were joining a system of fixed exchange rates that allowed the participating countries to sell their gold to the United States Treasury for $35 per ounce. The purpose of the agreement was to speed up post war reconstruction and to bring order to international finance.  As part of the agreement the IMF was formed as was the bank for international reconstruction and development. The agreement was ended on 15th August 1971 when President Nixon ceased trading of gold at a fixed price. This stopped the era of exchange rates being fixed but the other institutions remain and have an important role in global finance.

There is still plenty of gold in the ground to be mined but its status as a store of value plus its other relatively unique properties and attractions as a thing of beauty mean that the price of gold is more determined by the level of demand that there is for it.

Industrial demand is fairly stable and alternatives can be found for some of its uses. India represents the market most watched to judge the potential for demand for jewellery and for retail demand generally. Diwali is the time in the Indian calendar when wealth is celebrated.  This falls between October and November. Gold is a store of value in India and is a symbol of wealth and status especially among the rural population where practical considerations of portability and security help to explain the huge demand there in spite of the rise in the price of the metal.

Demand for gold from investors, however, is probably the main influence on the price as it is a recognised form of investment diversification.  Hedge funds and portfolio managers use it for this purpose and the introduction of Exchange traded funds (ETFs) some of which require the physical commodity to be held and which is highly accessible to the retail investor has led to the potential for massive increase in demand at a time of financial crisis.

Demand for gold rose sharply following the collapse of Lehman Bank and was a symbol of the low levels of confidence in the market over the years until 2011 when the price peaked.  Slowly confidence has returned and the price of gold has fallen. Incidents such as the Russian annexation of Crimea and the uprising in Iraq will have temporary but low level influence on the price provided the incidents do not escalate out of control. Many investors see gold as an essential part of their portfolio as a counter balance to other assets in a highly volatile and uncertain world.

Emerging Markets - Major Markets

By definition an emerging market economy is one that has a low to middle per capita income which is in the process of moving from a closed economy to an open market economy. They currently represent approximately 20% of global economies. Although China is considered to be one of the largest economies of the world it is still classified as an emerging market due to its developments and reforms and low capita income per head. In general, emerging markets are deemed to be fast-growing economies into which developed economies look for new sources of income, and through their investment the emerging economy’s production levels rise thus increasing their GDP.

The four largest emerging economies are Brazil, Russia, India and China, often abbreviated to the BRICs and the next four largest are Mexico, Indonesia, South Korea and Turkey. More recently, focus has fallen on Mexico, Indonesia, Nigeria and Turkey, now known as the MINT economies as the four emerging economies with the most promise.

Emerging market economies experienced a challenging end to 2013 as the interest rates of developed economies reached rock bottom, commodity prices eased, demand from China slowed and the Federal Reserve Bank in America commenced the tapering of quantitative easing. Fear grew that increasing interest rates in the developed economies would result in negative returns in emerging market economies.

In January 2014 the IMF predicted growth of 5.1% in 2014 and 5.4% in 2015 for emerging and developing economies compared with growth of only 2.2% in 2014 and 2.3% in 2015 for advanced economies.

It would be dangerous to treat all emerging economies the same and this is reflected in the various economic figures, as estimated by the IMF, and it is difficult to predict which sectors or countries will do best.

The IMF are currently predicting GDP of 1.8% in 2014 and 2.6% for 2015 for Brazil and inflation of 5.9% in 2014 falling to 5.5% in 2015 whilst unemployment is forecast to rise from 5.3% in 2014 to 5.8% in 2015. For Russia the figures are GDP of 1.3% in 2014 and 2.3% in 2015 together with inflation of 5.7% in 2014 falling to 5.3% in 2015 whilst unemployment is forecast to hold steady at 6.2% for both years. For India, GDP of 5.4% in 2014 and 6.3% in 2015 with inflation of 7.9% in 2014 falling to 7.5% in 2015. They do not have any unemployment rates for India. For China, the GDP figure is 7.5% in 2014 and 7.2% in 2015 with inflation of 3% in both 2014 and 2015 whilst unemployment is forecast to hold steady at 4.1%.

The MINT economies of Mexico Indonesia and Turkey all have stable inflation and public finances whilst Mexico, Nigeria and Indonesia are in the G20 bloc of developing nations.

Tapering will result in a fall in global dollar liquidity which could damage those emerging market economies who are heavily reliant on external financing of their current account deficits or those with domestic weaknesses. This could result in an outflow of foreign capital in the short term which would push their exchange rates lower and in turn lower the inflationary expectations. This would subsequently reduce economic activity and could result in a need to raise interest rates to maintain currency levels, thus causing domestic growth to stall. The countries most at risk of this are the “fragile five” of Brazil, South Africa, India, Turkey and Indonesia.

Fears of a slow-down in China has also put pressure on emerging market economies. Recent Chinese PMI data has shown that the economy there continues to contract, albeit at a slower rate. However, based on the average figure over the first quarter there is evidence of a small rise which could mean the GDP growth might improve in the second quarter from its recent low of 7.4%. There have been signs of an increase in both output and new orders, and in particular export orders, since the beginning of the year. The improving economic conditions in the overseas markets of the US, the UK, Europe and Japan should be feeding through to China’s export figures. Another sign of this pick up is the reduction in inventories of finished goods in China and an increase in the purchasing of raw materials.

Global growth in April was at its slowest rate since last October hindered by the sluggish rate of growth in the emerging market economies. The HSBC Emerging Markets Index, a weighted composite indicator from national HSBC Purchasing Managers’ Index showed that emerging market output growth remained weak in April recording only a marginal increase from 50.3 to 50.4, which is far short of its 8.5 year long run trend of 53.9. Both the manufacturing and services PMIs of the emerging markets were sluggish. 

The BRIC emerging economies all came in below 50. The most marked fall being in Russia where the PMI figure was the lowest recorded since May 2009. Business activity in India fell for the 9^th time in 10 months but there are hopes of a recovery following the recent general election results.

In the global table of manufacturing PMIs, the Czech Republic, came in second to the UK, ahead of Ireland, the US and Germany. Brazil, Russia and China were all below 50 whilst India managed to climb above 51. The only other country to record below 50 was Japan although this could be a temporary situation attributable to a sales tax hike in the country. Japan had seen strong growth in previous months as consumers brought forward their spending ahead of the tax increase on the 1^st April so it is likely that this will only have temporary impact.

Seven of the countries to record a PMI figure below the global average of 52 came from the emerging markets. These were Mexico, India, Indonesia, Turkey, South Korea, Singapore and Indonesia, whilst there was better growth in Vietnam and Taiwan.

For long term investors emerging market economies should continue to produce good returns despite the recent setbacks, however further volatility can be expected. Many of the countries have large young populations who aspire to Western standards of living. This will require huge investment from governments and structural reforms but should drive growth in these areas for decades. 

Darren Winters