Readers may have noticed I have a fascination with currencies. Whether it’s fiat, gold, cryptocurrency, or cigarettes for prison inmates, the store of wealth and exchange of value in physical or abstract form rather than barter is a fascinating economic tool. In the currency vein, you may have heard in the news lately about BRICS and a potential new currency from its member nations.
Starting from a high level, the BRICS group is an association of five major emerging national economies: Brazil, Russia, India, China, and South Africa. The term "BRICS" was coined to represent these five countries, which are seen as promising economic powerhouses with significant growth potential in the 21st century. One of the significant proposals made by the BRICS group recently was the creation of a common currency to reduce their dependency on the U.S. dollar and to enhance financial stability within the group. This subject allows me to dive deeper and expand into a small area from my May 2023 letter. My May letter focused on inflation and one point I gloss over is how the U.S. came to be the world reserve currency after gaining control of the lion’s share of the world’s gold during the second world war. I will continue to gloss over that in the interest of time, but pick up the discussion today in summer 2023 where the U.S. dollar has remained the unquestioned international trade currency for 80 years…until possibly now? The U.S.’s old nemesis, Russia, could be the trigger to a changing world financial order.
When Russia launched its invasion of Ukraine in February 2022, most of the world agreed this act required consequences. Not military warfare retaliation, but economic retaliation. With the dollar being the world reserve currency, the U.S. has a degree of jurisdiction if U.S. banking or financial infrastructure is used (or U.S. nationals are involved). To be abundantly clear, the U.S. can effectively cut financial flows anywhere at any time when U.S. dollars are used in an economy. It is for this reason why a U.S. sanction is effectively a global sanction.
The 2022 financial sanctions against Russia were extensive, and the U.S. was able to immediately immobilize, or seize, hundreds of billions of Russian-held U.S. dollars. This may have been the straw that broke the camel’s back in other countries rethinking the ability of the U.S. to dominate global trade and if this is too great a power for one country, The United States, to have. I won’t get into those arguments for and against this power and privilege, but I will get into what has happened in the last 18 months.
Following those sanctions, Russian trading partners have set up systems and methods to circumvent the sanctions placed on them for the aforementioned Ukraine invasion. China kicked things off by opening their financial system to Russia and, in doing so, has led the immense growth in trade between the two countries. China serves as an origin, destination, and intermediary for Russian money. Circumventing the western SWIFT payment systems that Russia used to use was not all that difficult as China has been building out the Yuan as an international alternative currency for over a decade. Coinciding with this, South American countries like Argentina and Brazil have implemented direct trading with China in Yuan rather than settling transactions in U.S. dollars as they have done for decades.
Finally getting to my point, the de-dollarization push with the strongest potential comes from BRICS. BRICS was originally just an acronym to describe the five fast growing nations expected to dominate the global economy by 2050, but in recent years the group has transformed into a loose intergovernmental organization similar to the G7 (United States, Japan, UK, France, Italy, Germany, and Canada). BRICS is now seriously working on creating a new international currency with the intent of dollar-free trade and pegged partially to gold. Rumors have swirled for and against this currency being a major topic in next month’s BRICS summit in Durban, South Africa. We shall see…
Many economists agree that given the scale and growth of the BRICS economies, a BRICS currency can pose the strongest challenge yet to U.S. dollar dominance. But is such a currency actually happening, or is this just media hype? Hype has happened before that ultimately resulted in no change to the U.S.’s global trade dominance. The Euro was originally expected to challenge the dollar as it is an inherently international currency. More than 25 years in, this competition has never quite materialized after the European debt crisis and the lack of UK integration into the Euro system stalled adoption. There is some evidence to say a de-dollarizing trend is materializing now though. Most to that point, the share of central bank reserves in U.S. dollars has declined in recent years in favor of gold.
History of the last 500 years tells us that there must be a dominant global reserve currency. The first reserve currency came from the Spanish, then the Dutch, then the British, and now the Americans. Can it ever go from one dominant country to a group of countries? I suspect no.
First, many BRICS nations may be cooperating at the moment, but they are not strong allies like the G7. China and India do not really care for one another and often get into deadly conflicts over their disputed border. In regards to Russia, can they be trusted not to invade a neighbor like Georgia, Chechnya, or Ukraine? Can the South Africans be trusted to not arrest Vladimir Putin in the BRICS meetings in Durban next month in satisfaction of international arrests warrants? That would certainly be interesting.
Second, a world reserve currency requires an open financial system, and China, the largest economy of BRICS, cannot allow that. The Chinese have capital controls in order to avoid a flood of capital escaping the country. Individuals are only allowed to send $50,000 of value abroad annually without permission from the state. China has accumulated a tremendous amount of wealth the last 30 years and has partially propped up their economy by forcing the capital to stay inside the country. Considering how hard the ultra-wealthy of China already work to get their money out of the country, opening up China to be a world reserve could lead to massive capital flight. On the other side, there are massive restrictions on foreign access to Chinese financial markets. Chinese stock exchanges are largely closed to foreign investors. The U.S. Dollar, in contrast, is open. Although a suspicious activity report may be filed, there are essentially no meaningful restrictions moving U.S. dollars in and out of the country. In fact, most dollars are held outside the United States.
There are few roads that lead to the U.S. losing international reserve status and trade supremacy. Though, currencies operate off a network effect; they are useful because everyone else is using them. Right now, the world largely agrees the weaponization of the U.S. dollar is primarily being used for good, such as the sanctions on Russia. Ultimately, the U.S. can only use a weaponized dollar because the weapon is granted by the rest of the world. The only way this privilege changes is if an overwhelming part of the international consensus decides the U.S. is not using the U.S. dollar for good or that they are devaluing the dollar too much. As of today, the Fed is working hard to keep a strong dollar.
I am eagerly anticipating learning more of the Aug 22, 2023 Durban, South Africa BRICS accords. News is breaking as I write this the BRICS currency project may be delayed or cancelled. Regardless of what happens next, the world is starting to consider a different financial order and that can affect you through secondary effects. Best to stay knowledgeable and on top of it.