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THE BIRTH OF THE BRICS

The idea had begun to form in my mind two months earlier. I had been in New York to address the National Association for Business Economics at the Marriott Hotel in the World Trade Center. The title of my speech was “The Outlook for the Dollar” and I drew heavily on my life as a foreign exchange economist. Not once did I mention the BRICs. In fact, at that time the only BRIC economy I gave much thought to was China. Two days later I was back in London, tired from the three-day trip back and forth across the Atlantic. At the time I was cohead of the Global Economics department at Goldman Sachs. It was early afternoon and I was taking part in an audio/video conference with our senior economists from all over the world. It was the best of globalization in action, diverse voices and opinions pouring in from New York, Tokyo and Hong Kong, with us pitching in from London.

My mind was taken up with the imminent departure of my cohead Gavyn Davies, one of the most respected economists in the world. He left the meeting early for his final job interview for the post of chairman of the BBC. A short while later he was back, with news that an airplane had struck the Twin Towers. Failing to appreciate the full extent of what was happening, we carried on with our meeting. A couple of minutes later our New York colleagues rose and disappeared from the video screen without explanation.

We all know what happened next in lower Manhattan. Over the next few days I received e-mails from friends and colleagues I had seen so recently in New York, people who had heard me speak at the conference, people I scarcely knew offering up their extraordinary tales of escape from the terror and turmoil of that awful morning. Some, in their confusion, were still asking for copies of the charts I had shown to explain my views on the dollar.

The same technology that had given us the ability to talk so easily to colleagues around the world could also convey the horrific reality of the devastation the terrorists caused. We could watch the towers burning and collapsing in real time. It was a chilling example of the immediacy of advanced technology and communication, its ability to strike a collective fear into the whole world. The nature of the media was clearly understood by the terrorists too.

The 9/11 attacks unleashed a cascade of thoughts that had been building in my own mind as my career progressed. They were linked to the pros and cons of globalization. I wondered whether there were better ways to think about economic growth around the world, some idea that could be shared and accepted by everyone, and would transcend nationalism.

Globalization, I felt, had come to be equated with Americanization, which was not always welcome in every part of the world. And yet the benefits of globalization—if only they could be understood on their own, without seeming to belong to any one country, culture or political system—seemed obvious. A more open exchange of goods, services, currencies and even political influence could lead to greater wealth for all, not just the elites.

Over the next couple of weeks, as people tried to recover a semblance of normality, Gavyn accepted the post of BBC chairman, and I was asked to assume sole leadership of the Global Economics department. It was a great honor, but also a great challenge. Gavyn had built the department into a world-class research group. His team had come to be regarded as masters of sophisticated and detailed analyses of the largest economies, especially the G7. How could I ever take over his mantle and maintain the department’s reputation?

A brief personal history might explain the reason for my apprehension. Until I joined Goldman Sachs in 1995, I had spent most of my years as a “dirty economist,” someone who mixed classical economics with the rough-and-tumble of the trading floor. My specialty was foreign exchange. I had fallen into the field in 1982, after my doctorate at the University of Surrey. I needed a well-paying job because I had borrowed so much during my education, and so I gravitated to the City of London. The traditional British clearing banks would have been an unlikely home for me, because I hadn’t been to the top schools or Oxbridge. In those days, such things still mattered more. The bank that did offer me a job was Bank of America. I confess I was naive: because the name was so similar to the Bank of England, I’d originally thought it was the London branch of the U.S. Federal Reserve rather than a multinational corporation. But the bank gave me a chance and I was grateful for it.

At Bank of America there were still strong traces of academic economics, which could reach the level of the absurd. The first country I was asked to analyze was Italy. Once a month I had a conference call with economists in the bank’s headquarters in San Francisco to discuss the five-year outlook for the lira. The currency was so volatile that often we didn’t actually know where it was trading on the day, never mind in the future. After a few of these meetings, I could tell you to the minute when someone would predict that Italy would soon default. Its debt/GDP ratio at the time was roughly where it is today: well over 100 percent. The fact that Italy kept stumbling along, and was not even close to default, suggested to me that finance was full of people claiming to know far more than they did.

I subsequently moved to Marine Midland in London and then in 1985 on to New York with the same firm. I loved New York. The meritocracy of the place suited me, the way the thing that mattered most was whether you were capable and if what you had to say made sense. As a trading floor economist, which is what I was when I went to New York, I was spending time in the noisy world of foreign exchange traders, and I learned from some of the most aggressive and talented of them.

Part of my job entailed me waiting for the telex machine to start printing. I would grab the latest news and interpret it. If the Bundesbank raised interest rates, what did it mean for the dollar/ deutschemark rate? How could the traders use this news? I had to make my formal training more immediately relevant.

The experience of watching the volumes and liquidity of the foreign exchange market made me realize that it’s like the world’s biggest fruit and vegetable store. Everyone knows everything all the time. There is no secrecy about the quality of the goods or what their prices ought to be. You can trade the euro/dollar exchange from eight p.m. on Sunday night to ten p.m. on Friday. There’s no other market like it, and if you want to make money, you are forced to take agile and sometimes contrary views. You have to ask yourself if other investors are in there too early or too late. You’ve got to be constantly on your guard against the lazy consensus, because one shift in a market that is so big and liquid, where there’s so much information, and you can easily get caught out.

Trying to be permanently smart in this market is tough. It’s why it tends to attract larger-than-life characters, people who are ready to take big, risky positions, with the possibility of great gain or loss. Only they can buck the powerful groupthink in foreign exchange trading. (In this regard, fast-forward to spring 2010, when I was chairing a discussion at a Goldman Sachs conference of chief investment officers. It was just as the European crisis surrounding Greece broke out, and I asked the question: “Who thinks the euro is going to be stronger against the dollar by the end of the year?” Two people raised their hands. Then I asked: “Who thinks it’s going to be weaker?” Everyone else raised their hands. Of course, by the end of the year, the euro was a lot stronger. Experiences like these shaped how I think as an economist trying to make sense of the world.)

In 1988 I joined the Swiss Bank Corporation (SBC), working in fixed-income and equity markets. Within a year I was running the bank’s global research network, learning about equities as I went. I realized that my job as head of a research unit, aside from managing people, was to come up with just a few interesting ideas to communicate both inside and outside the bank. I was encouraged to think about the potential growth of a bond market to serve the European Community, as the European Union was then called, perhaps because I was surrounded by several continental colleagues who seemed very absorbed by the idea of the European Monetary Union (EMU).

At the time the idea of a single currency was still very much in the planning stage, but I was persuaded that the process was unstoppable, and that inevitably the various European domestic bond markets would adapt to this new reality. In fact, it had been possible to buy bonds denominated in this as yet unadopted common currency since 1981. What would become the euro was then known as the European currency unit, or ECU. In 1990 I created a model to track ECU bond trading, which, although idiotically simplistic, helped brand Swiss Bank as a credible player in this market.

The EMU turned out to be a good learning process for me, in terms of focusing on the big picture. I had already learned a lot about the various major European currencies from my Marine Midland days. Many traders I knew specialized in just a couple of trades, for example the yen against the lira. The volatility of Italy’s currency meant there were always ample opportunities for both making and losing money, and many traders shed a tear for its passing. The arrival of the euro forced the foreign exchange world to seek out new opportunities, to cast our gaze around the world.

Coincidentally, 1990, the year I developed the ECU bond model, was also the first year I visited China. I’ve been there at least once a year every year since then, at first to talk to the people who managed foreign exchange reserves at the Bank of China (some of whom have become good friends). I didn’t realize it at the time, but those early visits were paving the way for the story that would later dominate my professional life.

In the early 1990s I joined the growing crowd of economists who believed the U.S. dollar had to weaken. I expected that the dollar would fall sharply against the Japanese yen. I did not think the United States could cope with its external balance without letting its currency devalue. I was proved right, and this call on the U.S. dollar/yen is what probably made me more widely known in the investment banking world and among hedge funds. By the mid-1990s I had joined Goldman Sachs as a partner. Once there, I was constantly seeking ways to prove myself worthy of my place among the best team of economists at any major bank, always casting around for ideas.

I had come to look forward to my regular visits to China and could see the changes every time I went. But the event that transformed my view of China was the 1997 Asian economic crisis, when the value of currencies throughout the region collapsed. My interpretation of the crisis was that while excessive borrowing by many Asian countries might have been the core cause, equally significant was the reversal of the yen’s strength in mid-1995. When it started to become clear that Japan would struggle to recover from the bursting of its asset bubble, and that interest rates would stay really low in Japan, the yen weakened notably through 1996 and 1997. For many other Asian countries whose currencies were linked to the dollar, this represented quite a problem. From 1973 to 1997, the yen had risen from ¥400 to ¥80 against the dollar, and Asia probably believed that the yen would continue to rise forever. When it started to weaken, as it did in mid-1995, it began to expose all the Asian countries and companies that had borrowed huge amounts in dollars. As long as the yen was rising, their debts were manageable and shrinking, as they could pay off their dollar debt with the yen they received by selling their exports to the Japanese; the moment the yen weakened, the cost of servicing and paying down that dollar debt began to rise. In addition, as the dollar rose against the yen, the price of these countries’ exports rose, and Japanese investors were less attracted to these countries. Starting with the Thai baht, currencies across Asia began to tumble.

If history was any guide, the crisis should have clicked its way through the various Asian countries and finally caused utter chaos in China. Instead, the Chinese demonstrated a kind of astuteness and global awareness I hadn’t seen before. They appeared to think that in order to avoid contagion from the crisis, they would have to take a global view and role rather than local ones.

Since the root of the problem was the relationship between the dollar and the yen, the Chinese called the White House and told the Americans they had to intervene. They even threatened to devalue their own currency, the renminbi (also called the yuan), if the Americans resisted, which would probably have escalated the crisis even more. Supporting the yen would be against the stated U.S. policy in favor of a strong dollar, but President Clinton and his treasury secretary, Bob Rubin, listened and began buying the yen. It worked. The contagion was stopped, and China had demonstrated that it possessed economic brains and growing political brawn. Some argue about the impact of U.S. intervention and say that other factors took the heat out of the Asian crisis by strengthening the yen. But in my book, the Chinese had played an important global role and persuaded the Americans to support their position. I for one was impressed.

 

 

 

That started me thinking about how the structure of the world economy was changing and what that would mean for certain developmental and policy issues. As an economist specializing in foreign exchange markets, I had grown up with the G5 and G7 playing the defining role in global economic policy.¹ In 1985 the original “Group of Five”—the United States, Japan, France, West Germany and the United Kingdom—had gathered at the Plaza Hotel in New York to sign the Plaza Accord, agreeing to intervene in currency markets to depreciate the value of the dollar in relation to the yen and the deutschemark. In 1987 those five countries plus Canada and Italy, the G7, had conspired again, this time at the Louvre in Paris, to try to halt the decline in the dollar they had triggered two years earlier. These two events had a major impact on my career and how I thought about markets and economic policy. The world’s economic policy at the time was shaped by a small group of people from a handful of countries meeting in luxury hotels and grand museums. One of my mantras for successfully analyzing the foreign exchange markets became “Never ignore the G7.” They seemed so powerful, and when they were determined, very successful.

The creation of the European Monetary Union, and the merging of so many currencies into a single one, had already made clear to me that the G7 had outlived its usefulness. If Germany, France and Italy now had a single monetary policy and currency, what was the point of each of them showing up at G7 meetings? A single representative would suffice. In addition, extrapolation of growth patterns of the late 1990s (and China’s ability to withstand the strains of the Asian currency crisis) showed that, not long after the millennium, China would overtake Italy in terms of GDP, and soon afterward be up there with France, the United Kingdom and Germany.

The case for reform of the G7 was obvious back then; it is quite remarkable that it took the United States until 2008 to lead the revival of the G20, an already existing though moribund grouping comprising nineteen major countries plus the European Union, which was the first real step down this path.²

 

 

 

In 2001, what particularly interested me about Brazil, Russia, India and China was that they all appeared increasingly eager to engage on the global stage. Whatever had occurred in their past was over and done with. Globalization was happening and they wanted to be part of it. The Internet was obviously helping, enabling companies to outsource more and more activities to cheaper parts of the world. China was an easy pick, given its size and the enthusiasm of its leaders to embrace capitalism—or at least large parts of it. What also intrigued me was that the more I visited these countries, and the more dealings I had with the senior officials and their underlings over many years, the more I realized that they were equally well informed about the world as I was. If those billion-plus people had access to the same technology and advantages enjoyed in the West, their progress would be prodigious.

There were other unique economic factors that determined the BRICs’ status as being countries to watch. That India’s demographics were so powerful, and the fact that so many Indians spoke English, put them in a great position to benefit from the Internet and the boom in outsourcing services. Here was another nation of more than 1 billion people that seemed to want to embrace globalization and to allow its workforce and products to enter the global marketplace. I thought this could be the start of a whole new era for India. Lots of smart Indian businesspeople could bring international business to Indians, and the benefits of India to the rest of the world.

Russia had already been invited to join the G7 in 1997 as the West sought to encourage the country toward free markets and democracy following the collapse of communism. By 2001 the G7 leaders had given up on Russia to a degree. The replacement of Boris Yeltsin by Vladimir Putin had slowed Russia’s progress toward capitalism, to the disappointment of the West. This mind-set lies at the heart of why some Western observers today find it so easy to be skeptical about Russia. As I will discuss later, Russia can still generate the economic might and opportunities that the G7 perceived back in the 1990s. However, it may just be delivered in a different style from that expected by the G7 when they became the G8.

The case for China, India and Russia was obvious, but I was trying to think globally, and wondered if I was missing something. I hadn’t really thought that closely about Latin America, but there were two countries there with large populations: Brazil and Mexico. Brazil seemed an increasingly likely candidate because, like China during the Asian crisis, it had recently become a more thoughtful economic player. Around this same time, Argentina had broken the link between its currency and the dollar and defaulted, seemingly joining much of the rest of the continent in economic struggle.

There were signs that Brazil was starting to go in a different direction, and not a moment too soon. Brazil had been a democracy since the early 1960s, but it had always struggled to achieve the stability essential for making serious economic progress. The problems of corruption and inefficiency were endemic. For ordinary people, that manifested itself in daily life with prices so volatile it was impossible to predict how much anything would cost. One of Goldman Sachs’ own Brazilian economists told me that, when he was a teenager, Brazilian inflation on a daily basis was what it is today on an annual basis. In my professional lifetime, Brazil has had four different currencies, a reflection of the economic chaos that has plagued the country. In the 1990s alone, Brazil went through three financial crises. For years, rich Brazilians converted their money and shoved it out to Switzerland as quickly as they could, before it became worthless.

This all changed in the late 1990s, when a new set of political leaders, led by President Fernando Henrique Cardoso, set about bringing inflation under control and improving the country’s fiscal health. I strongly believe that taming inflation is essential for any economy to grow on a sustainable basis. People need to know what their money will buy. If they can’t trust prices, they won’t invest or do anything to improve their future. Without giving people the sense that whatever they earn and save is going to have value, no politician can talk seriously about sustained growth. If I could recommend only one policy to any country hoping to join in the success of the developed world, it would be this: target inflation and hold it down. Brazil’s opportunity came in the brief period after 1999, following yet another economic crisis. Brazil’s leaders floated the real, letting it promptly drop in value, and appointed Arminio Fraga, a fan of inflation targeting, as the new head of the central bank. By placing the control of inflation at the center of macroeconomic policy, it at last seemed that Brazil’s leaders had the will to end the hyperinflation cycles of the previous two decades, and give their country a serious chance to reach its potential.

But with so many unknowns, the inclusion of Brazil was undoubtedly the biggest, boldest bet I took when I wrote my 2001 paper. I can’t resist saying, in the spirit of the amusing debate back in those days about why I included the B in BRICs, that Brazil also happens to produce some of the world’s best soccer players (an ongoing subject of obsession for this author).

So I arrived at the point of creating an economic grouping and realized that, by taking the initial capitals of the names of these four nations, I could make an acronym that was particularly apposite, for these four BRICs, with a total population of around 2.8 billion, might indeed be the new “bricks” from which the modern economy would be built. The 9/11 attacks had forced my collection of observations into a coherent form. Perhaps if I could envisage and, indeed, contribute to a world in which there was no unequivocally “right” way and no “accepted” leading nation—one in which we all tolerated each other under some commonly agreed international principles of conduct—then this world could be a better and safer place.

Globalization didn’t need to be Americanization; there was scope for the other parts of the world to create their own definitions of the term using their own characteristics. Even today there are Americans who seem to feel that allowing China to grow as big as the United States would represent a challenge to everything America stands for. In 2001 that attitude was rife. I wanted to put a stop to this kind of thinking: to help people see globalization as benefiting everyone. This is what underlay the November 2001 paper and what has greatly influenced me ever since. In this book I will outline how these four nations have progressed far beyond even my own expectations, how their actions have encouraged and inspired other emerging nations to join the global economy, how they are helping the post-2008-crisis West recover its economic health and why they will be crucial to a better economic future for us all.