Brazil’s central bank announced today that transactions between China and the South American nation will increasingly use their own currencies rather than use the US dollar.   Rumors of a Chinese/Brazilian move to break away from USD hegemony first surfaced at the G20 meeting in London last month.  This week, with Brazil’s president Luiz Inaςiao Lula Da Silva involved in high level economic talks in Beijing,  it seems the rumors are swiftly turning into actual policy initiatives.

SKY reports:

The move is significant for two reasons: not only is it a direct challenge to the dollar as the world’s transaction currency of choice but it is coming from two countries with some of the world’s largest foreign-exchange reserves—most of which are held in (yes, you’ve guessed it) dollars.

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It’s not the first time we’ve heard such posturing. A year ago China – the world’s largest consumer of U.S. government debt – warned it could move those assets into better performing currencies like the euro and as recently as March, the country’s central bank governor pondered replacing those dollar holdings with a standard reserve such as the one used by the IMF. Such words have in the past seemed idle threats but with the prospects of countries like Brazil, Russia, India and China (the so called ‘BRICS’) outpacing shrinking markets in West, a currency agreement between such emerging market titans could challenge the monetary status quo.

We’re still extremely curious as to the specifics of this somewhat “apples and oranges” agreement between the two currencies.  Brazil’s currency floats like any other major currency on world FX markets, while the Chinese renminbi is carefully managed by Beijing at just under 7 per dollar.   It is also interesting that the arrangement is not exclusive and still allows either nation to use USD as a matter of choice — a flexibility which doesn’t exactly ring of confidence in either one of the competing currencies.

The Financial Times reports:

An official at Brazil’s central bank stressed that talks were at an early stage. He also said that what was under discussion was not a currency swap of the kind China recently agreed with Argentina and which the US had agreed with several countries, including Brazil.

“Currency swaps are not necessarily trade related,” the official said. “The funds can be drawn down for any use. What we are talking about now is Brazil paying for Chinese goods with reals and China paying for Brazilian goods with renminbi.”

An aide to Mr Lula da Silva on his visit to Beijing said the political will to enact a similar deal with China was clearly present. “Something that would have been unthinkable 10 years ago is a real possibility today,” he said. “Strong currencies like the real and the renminbi are perfectly capable of being used as trade currencies, as is the case between Brazil and Argentina.”

While many economists scoff at the relative strength of both the Renminbi and the Real — and point out that a real shift away from USD hegemony would take decades to occur, we must point out the following 3 facts which are inescapably true:

1. The United States has a massive debt which is growing larger.
2. The trade deficit in the United States continues unabated.
3. The Federal Reserve has shown that it is willing to “print” dollars as a response to liquidity issues within the US banking system.

We continue to watch with concern as the Federal Reserve continues to throw money at the weakest parts of the US economy, tarnishing the dollar and preserving those parts of our economy which should be allowed to fail.  If Ben Bernanke believes that such actions won’t ultimately destroy the privileged role of the US dollar — he is seriously mistaken.

Preliminary results show that India’s moderate Congress Party has swept national elections, re-electing Prime Minister Manmohan Singh with a parliamentary majority which promises to see much needed political reforms instituted in the world’s largest democracy.  State television says Congress’s alliance has won or is ahead in 263 seats, compared with the BJP’s (154), the Third Front (60) and others (66).

NPR Reports:

Defying almost all predictions of a tight national election, a hung parliament and weeks of political horse-trading, hundreds of millions of Indian voters have given the incumbent prime minister, Manmohan Singh, and his centrist United Progressive Alliance an unexpected and surprisingly decisive victory.

The winning margin was so large that Singh’s Congress party and his closest allies, with 260 seats and two races undecided, came close to a 272-seat majority in the 543-seat parliament. The assumption that India, with its many divisive communities and ideologies, was doomed to weak coalition governments for the foreseeable future was swept away in ballot boxes across the country.

This result has the potential to do away with the tense coalition politics of his last term in which the communists fiercely opposed any reforms put the brakes on moves to free up the economy.

India’s Sensex index gained 17% on the news, forcing the Bombay Stock Exchange to shut down for the day.

Bloomberg reports:

“This is an absolute game changer,” said William Nobrega, the co-author of ‘Riding The Indian Tiger,’ who advises U.S. companies on investing in the world’s largest democracy. “It can truly move India in a much faster pace to where it deserves to be in the global economy.”

Political stability will make India a more attractive investment destination as Singh, 76, seeks the funds to stimulate Asia’s third-largest economy.

“There were so many major initiatives that were sidelined,” Nobrega said. “It will have a phenomenal boost on the Indian economy this year and next.”

Singh is the first Indian Prime Minister to be re-elected to office after serving a full five-year term since first PM Jawaharlal Nehru.

AFP Reports:

As finance minister in the early 1990s, Singh initiated the sea change that began the opening of India’s inward-looking economy to the world, earning him the sobriquet of the country’s economic “liberator.”

A former governor of the International Monetary Fund, Singh became the first Sikh prime minister of [India]… when he was nominated for the job by Sonia Ghandi when the Congress Party returned to power in 2004.

After a heart bypass operation in January, Singh took only a minor role in the elections, leaving the campaigning to Rahul Gandhi, the heir of the Nehru-Gandhi clan, and his mother Sonia Gandhi, who is president of the Congress party.

Now Singh — a married man with three daughters — is expected by many observers to step aside midway through his new five-year mandate for Rahul.

In what could amount to extraordinarily serious and dangerously destabilizing global event, the government of India announced today that Pakistani extremists may already be in  control of nuclear weapons sites in Pakistan.  This is particularly concerning given that Pakistan already has the world’s worst record for proliferation of nuclear technologies to date.  (In 2004 the founder of Pakistan’s nuclear program,  A.Q. Kahn confessed to being involved with a clandestine international network which was engaged in proliferation of nuclear technologies to Iran, North Korea and Libya — and is believed to have supplied Iran and North Korea with gas centrifuges and uranium hexaflouride.)

The Times of India reports:

India’s Prime Minister Manmohan Singh has told President Obama that nuclear sites in Pakistan’s restive frontier province are “already partly” in the hands of Islamic extremists, an Israeli journal has said, amid considerable anxiety among US pundits here over Washington’s confidence in the security of the troubled nation’s nuclear arsenal.

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There was no official word from either Washington or New Delhi about the exchanges, with India in the throes of an election and US winding down for the weekend. But US experts have been greatly perturbed in recent days about what they say is Washington’s misplaced confidence in, and lackadaisical approach towards, Pakistan’s nuclear assets. The disquiet comes amid reports that Pakistan is ramping up its nuclear arsenal even as the rest of the world is scaling it down.

“It is quite disturbing that the administration is allowing Pakistan to quantitatively and qualitatively step up production of fissile material without as much as a public reproach,” Robert Windrem, a visiting scholar with the Center for Law and Security in New York University and an expert on South Asia nuclear issues told ToI in an interview on Thursday. “Iraq and Iran did not get a similar concessions… and Pakistan has a much worse record of proliferation and security breaches than any other country in the world.”

Windrem, a former producer with NBC whose book “Critical Mass” was among the first to red flag Islamabad’s proliferation record going back to the 1980s, referred to recent reports and satellite images showing Pakistan building two large new plutonium production reactors in Khushab, which experts say could lead to improvements in the quantity and quality of the country’s nuclear arsenal. The reactors had nothing to do with power-production’ they are weapons-specific, and are being built with resources who diversion is enabled by the billions of dollars the US is giving to Pakistan as aid, he said.

Windrem also pointed out that Khushab’s former director, Sultan Bashiruddin Mahmood met with Osama bin Laden and his deputy, Ayman al-Zawahiri, and offered a nuclear weapons tutorial around an Afghanistan campfire, as attested by the former CIA Director George Tenet in his memoir “At the Center of the Storm.” Yet successive US administrations had adopted an attitude of benign neglect towards Pakistan’s nuclear program and its expansion at a time the country was in growing ferment and under siege within from Islamic extremists.

US officials, going up to the President himself, have repeatedly said in public that they have confidence the Pakistani nuclear arsenal will not fall into the hands of Islamic extremists, and they have Islamabad’s assurances to this effect. But scholars like Windrem fear Pakistan’s nuclear program may already be infected with the virus of radicalism from within, as demonstrated by the Sultan Bashiruddin incident.

This comes on the heels of last Wednesday’s announcement by Pakistani president Zardari’s announcement that Pakistan’s nuclear facilities are secure:

As the AP reported last Wednesday:

Pakistan’s president is rejecting concerns that his country’s nuclear arsenal was in jeopardy.

The concerns are prompted by a surge in Taliban activity, and growing instability.

In London today, Asif Ali Zardari said Pakistan’s secret nuclear sites are secure. But he wouldn’t specify what safeguards are in place.

He says “anyone who is responsible in any government” will say that they are not concerned about the situation in Pakistan.

With due respect, Mr. Zardari — it would be the height of irresponsibility to not be overtly concerned at this juncture.  By many accounts, the government of Pakistan is currently perched at the tipping point, and by some estimates could fall to opposition within a matter of days.  .

President Obama has downplayed the situation, calling the threat of proliferation “overblown”.

The Atlanta Journal Constitution reports:

The Pakistani government and President Barack Obama say concern over the security of the nuclear weapons is overblown, and the country’s still-powerful army gives top priority to guarding them.

“I’m confident that we can make sure that (they are) secure,” Obama told reporters last week, adding the army “recognizes the hazards of those weapons falling into the wrong hands.”

But we must address the semantics of “proliferation”.  At this time, the potential of an outright theft of an intact nuclear weapon is likely to be an extremely low-level threat (although India’s announcement today certainly raises the threat level), and actually launching a missile would be impossible without acquiring centralized control.  Furthermore, it is believed that Pakistan’s nuclear arsenal is stored in an incomplete, disassembled state for security reasons, with warheads and missiles stored separately (although one must assume, within some geographic proximity).

Complicating the matter of monitoring the situation, is that Pakistan’s nuclear arsenal is stored on Soviet-style mobile launchers and rail-freight lines — making sattelite tracking of Pakistan’s weapons difficult for foreign intelligence agencies.

But “proliferation” of dangerous radioactive materials is indeed a real threat at this time .

Reuters reports:

Two scenarios are particularly worrying, analysts say.

If the Taliban encroached close to an area where warheads are stored, the military may feel it needs to try to move them — and the convoy could be vulnerable to capture.

“The Pakistani military say their procedures for moving nuclear weapons are very well thought out, but that is always a weak point, moving your nuclear assets,” Kuusisto said.

The second, and likelier, scenario would be that despite the vetting procedures in place, Taliban or al Qaeda sympathisers managed to get employed in a nuclear facility and were able to steal enriched uranium or other radioactive material.

Vetting of personnel can never be foolproof.

“What chills me is that the military says personnel assigned to sensitive nuclear facilities are all vetted by the Pakistan intelligence service,” said Steve Vickers, president and chief executive of FTI-International Risk and a former head of criminal intelligence for the Hong Kong police.

Now, in light of the government of India’s statement that “nuclear sites” may already be compromised, we must ask specifically which scenario they are describing?  Neither one of course, bodes well for global stability or for keeping the lid on the nuclear genie.

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The Wall Street Journal and  The Financial Times both ran euphoric stories this week about recent gains in emerging markets, driven primarily by US and European funds pouring back into markets such as Brazil and Russia and supported by recent positive movements in oil and metals prices.

Both articles quote identical statistics:  Brazil’s Bovespa equity index is up 75% from market lows.  Russia’s RTS index is up 80 per cent from its low last year.  The MSCI Emerging Markets index has risen more than 50 per cent since its low last October, with a large proportion of the gains coming in the past few weeks.  Neither article mentioned that the MSCI Emerging Markets Index is still down about 60% off its peak in 2007 or that  steel is still on average more than 40% off its highs in June 2008.

According to the FT, “Strong performance has been fueled in part by a realization that these markets were oversold at the end of last year. Investors, spooked by the banking crisis in the UK and US, suddenly became risk-averse and withdrew large amounts of capital from BRIC markets.”

“Behind the optimism,” adds the WSJ, “are signs the worst of the global slump may have passed, and that China’s massive stimulus plan is kicking in, heralding a pickup in demand for commodities and agricultural products.”

But is this all only so much wishful thinking?  Brazil’s central banker Henrique Meirelles strikes a more realistic tone:  “Brazil is showing signs of recovery on the margins, but that doesn’t mean [the crisis] is over.”

Nonetheless, foreign capital is pouring into the country – about $3.7 billion this year.  Meirelles is in a situation now where the Brazilian Real has appreciated 5% against the dollar in the past week, largely the result of over $1 billion of new capital entering the country in the past two weeks.

China’s Stimulus Program

Recent data suggests that despite persistently weak demand for Chinese exports in overseas markets, the effects of China’s fiscal stimulus are beginning to appear.  Beijing has pumped billions of dollars into construction projects and other spending aimed at stimulating demand and propping up growth.  Without a recovery in the export sector, however, these initial results may be short lived.

According to Li Shufu, chairman of Geely, one of China’s largest private carmakers, last month’s 10 per cent rise in passenger vehicle sales “is driven by a temporary policy” and represents “superficial growth.”  “Only a strong recovery of the economy can help the Chinese auto market,” he concluded.

Michael Pettis, a professor at Peking University’s Guanghua School of Management, explains:

China is not likely to collapse economically, and we may see one or more “rebounds” over the next few years, but the glory days of growth are well and truly behind us until the financial system is sufficiently reformed that it leaves behind governance constraints that almost automatically assure systematic and massive capital misallocation. That will take many years. Meanwhile the transition to a healthier and more balanced economy – which was slated to be long and difficult in the best of cases – is likely to be longer and more difficult as a consequence of the fiscal and banking response to the crisis.

Admittedly, China’s financial stimulus efforts and more specifically their moves to replenish strategic commodities reserves are moving metals prices globally.  The real movement in emerging markets equities, however, seems to be purely American in origin.  Billions in quantitative easing, bailouts,and the recent ‘investor-sponsored’ bank recapitalization of the current US stock market rally have led to an environment in which Wall Street investors are optimistic about an economic recovery and are willing to gamble on depressed emerging market energy and commodities plays outperforming in the event of a recovery.

We’re sorry to say, but it smacks of a gambling addict doubling down in a casino in a desperate effort to win back everything he’s just lost.

Oil prices rose briefly back above $60 today on news that China’s demand for oil rose 14% in April and is now approaching record volumes of imports.   At the same time, car sales in China hit a historic record last month as a result of China’s aggressive economic stimulus measures.  What is even more telling is that China has embarked on a buying spree for commodities, driving up prices for a variety of raw materials.

While China’s national news service attributes the increased demand for commodities as a direct result of growth, what this says to us is that China is becoming increasingly nervous about the buying power of its enormous stockpile of US Treasuries, and is seeking to rapidly exchange them for a basket of  alternative value-preserving assets.

Bloomberg reports:

Deliveries reached 16.17 million metric tons last month, or 3.9 million barrels a day, a statement on the Chinese customs department’s Web site showed today. Oil also climbed as the dollar fell to the lowest level against the euro since March, bolstering demand for commodities as an alternative investment.

The rising price of oil comes at a time when U.S. demand for oil has fallen to it’s lowest level in ten years.  There is rising concern among economists that the higher price of oil might reduce the chances of economic recovery.

The Wall Street Journal reports:

Oil’s rapid return to $60 has sparked concern that rising prices could slow an economic recovery. Noting that a $10 a barrel rise in oil prices translates into a $5.5 billion monthly hit to U.S. consumers and industry, J. P. Morgan analysts recently said that “in the current fragile economic state, [rising oil prices] may be an unnecessary shock.”

While the concern of higher oil prices is indeed valid — as high oil prices reduce the capacity for business, and the level of disposable consumer income — we are still a far cry from last year’s $145 a barrel.   Furthermore, it should be noted that higher prices as a result of stimulus are not sustainable unless the stimulus creates real growth.  At this point, that isn’t something we’re seeing.

Politically, Thailand is still experiencing a difficult period of conflicting interests — but just as concerning are the nation’s current economic difficulties, and their proposed remedies of fiscal stimulus which could create a potentially dangerous debt to GDP imbalance for the mid-  to long-term.

Xinhua reports:

Thailand’s public debt in the future may exceed 60 percent of the country’s gross domestic product (GDP) as the outcome of the government’s economic stimulus packages to shore up the sluggish domestic economy, Prime Minister Abhisit Vejjajiva said Thursday.

However, the public should not panic since foreign countries still have confidence in the Thai economy, he told participants of the National Economic and Social Council meeting, the Thai News Agency reported.

Abhisit made the remarks after Pongpanu Svetarundra, director-general of the Public Debt Management Office, said earlier this week Thailand’s public debt at ending of February stood at about 3.59 trillion baht (101.85 billion U.S. dollars), or 40 percent of GDP.

During 2010 to 2012, the Thai government plans to spend 1.57 trillion baht (44.54 billion U.S. dollars) in investment projects to jumpstart the economy.

This is of course, a dangerous game:   Massive infrastructure spending to the tune of 1.57 trillion baht could indeed provide much needed economic stimulus in the short term, but debt created from such fiscal policies could just as easily become  a ball and chain around the ankle of the Thai economy for years to come.  Foreign financiers remember only too well, the rapid depreciation of the baht in 1997 which precipitated the Asian financial crisis.  Abhisit’s call to “not panic” because foreign financiers still have “confidence” in the Thai economy may indeed be true for the time being, but one has to ask “for how much longer?”, particularly when public debt represents the lion’s share of GDP.

While we watch Thailand’s economic health with deep concern, we do see a potential silver lining within the proposed stimulus:  A possibility for a return to social stability within the kingdom and a reconciliation of the  political differences which have flared in recent months. (Especially if a portion that $44.5 billion stimulus is spent to the benefit of less developed areas of the nation, which have participated less fully in the past decade’s economic growth).