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China and Brazil Ask, "Why Bother With Dollars?"

Worldwide economic weakness is reshaping the proportions of global trade. With its demand for soybeans, iron ore and oil back on their growth trends, China has become the largest importer of Brazilian goods, displacing the U.S. from its decades-old position as Brazil's biggest trading partner. As a result of the growth in business between the two countries, China and Brazil are working on a way to cut the dollar out of their growing trade loop and to settle accounts with Chinese renminbi and Brazilian reals instead.

The two countries haven't worked out the details, and by itself this move wouldn't cause a dollar collapse. But it's more evidence that the greenback could be losing its prominent place in the world economy.

Total trade between China and Brazil reached $3.2 billion in April, and volume in 2009's first four months was up 64 percent. China and Brazil have worked for several years to boost trade between the two countries, and Brazil is one of the few countries that exports more to China than it imports.

The dollar is the default currency for many types of international transactions, but in the context of the current economic crisis, President Luiz Inácio Lula da Silva of Brazil wants to bring an end to the dollar's dominance over trade. Brazil struck a deal last year to settle trade with Argentina in reals and pesos, and the Brazilian central bank is now working on a similar deal with China to eliminate the dollar middleman.

"[B]etween Brazil and China, we need to establish a trade that is paid for in our own currencies," Lula da Silva said in a recent interview with the Chinese magazine Ciajing. "We don't need dollars. Why do two important countries like China and Brazil have to use the dollar as a reference? ... Otherwise, we'll be in an absurd situation, where the country that caused this crisis will be the country that gets the most dollars."

China, too, has voiced concern about the dollar, although more from the perspective of owning trillions of dollar-denominated assets. (I wrote last week about senior Chinese officials warning the U.S. about a weak economy and dollar.)

Assuming this program goes through, would there be damage to the dollar? In the terms of the world currency markets, where it's estimated $3 trillion changes hands every day, this one China-Brazil deal is fairly small, making up maybe $70 billion a year in total transactions.

And it might have evolved on its own as a consequence of the growth of the emerging market economies, and their moving to the world stage. But I see two important messages here.

First -- economics aside -- because recent U.S. governments haven't made our South American neighbors a priority, those nations apparently feel little loyalty to us.

"The countries are also increasingly cooperating on security issues from military supplies and especially a joint satellite program," writes Rachel Ziemba of RGE Monitor. "How this will be used is uncertain but it is a sign of the deeper ties that may evolve over the next few years and decades and could provide a challenge to the U.S."

Second, the U.S. hasn't kept its economy in good shape. Our lenders are starting to reduce their exposure to the risks it poses, albeit so far mostly in small ways such as this trading program. The U.S. needs to emerge from this recession in strong shape, or risk becoming an also-ran in the global market.

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