No, BRICS Will Not Replace the US Dollar. However...

De-dollarization sentiment is building amid the global shift to multipolarity, but what does the data indicate about dollar divestment?

Online sentiment suggests support for de-dollarization is growing as the world shifts to a multipolar geopolitical terrain. It intuitively follows that as more countries consolidate their economic heft, geo-financial leverage trails it. Fair enough.

The informal acronym turned-formal-organization BRICS (Brazil, Russia, India, China, South Africa) has been at the center of the de-dollarization debate. Its sheer size across multiple dimensions makes it easy to understand why.

Collectively, the geopolitical/economic bloc accounts for 37.3% of the world's GDP, which is more than half of the EU's 14.5% and represents 46% of the world's population, nearly double the Group of Seven's (G7) 10%.

Despite all this, the Greenback continues to reign supreme. However, the push for de-dedollarization is not something Western policymakers should scoff at without meriting some reflection.

The US Dollar will not be displaced anytime soon as the world’s reserve currency. But growing de-dollarization efforts indicate Washington must reevaluate and shift its geo-financial strategies to avoid pushing its allies and enemies closer into adversarial blocs.

Brief Historical Context

The global economy has been operating under a US-led financial, economic, security paradigm since the end of World War II. The US Dollar was and remains central to this system:

1. 90% of all FX transactions involve the US Dollar

2. Half of global trade and 75% of Asia-Pacific trade are denominated in US dollars

3. Close to 100% of crude oil transactions are conducted in U.S. dollars

More generally, the US Dollar is the:

1. Invoicing currency in international trade 

2. Leading currency across global financial infrastructure 

3. Pricing power in major global commodities

4. Development financing 

5. Bank deposits

6. Global corporate borrowing 

7. Leading currency in terms of investability as it dominates global equity markets 

8. Primary safe-haven currency in times of economic and financial crises.

The global security architecture post-WWII also created the conditions for global trade to expand. Consequently, a convergence of security, economic, and financial forces created standardized protocol for international affairs.

But that’s changing now.

BRICS

Most recently, Malaysian Prime Minister Anwar Ibrahim stated in an interview with Chinese news outlet Guancha that Malaysia has made the decision to join BRICS and will soon begin the formal accession process.

As of January 1, 2024, six new countries have joined BRICS. These countries are Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates. Argentina was also invited to join but later decided not to participate under the leadership of its new president, Javier Milei, who has a more hawkish stance towards China.

While impressive on the surface, closer inspection shows half of the parties above are reeling from economic, political, and financial woes. Ethiopia’s inflation rate stood at 23% in May, and its currency, the Ethiopian Birr, is significantly overvalued. It has a disparity of nearly 100% between the official and parallel market rates.

As for Egypt, inflation is expected to average 32% in fiscal year 2024 (which runs from July 2023 to June 2024), and the Egyptian pound depreciated sharply, falling by around 50% against the USD in 2023 alone.

Iran, which has been under sanctions since 1979 and has been a political pariah ever since, relying on authoritarian regimes in China and Russia to access credit markets.

What do all these countries have in common? They need BRICS, specifically Chinese funds and investment more than anyone else. Their addition to the group would likely be more of a drain than a contribution in the short to medium term.

Why the Greenback is Here to Stay

BRICS says it's in the final stages of completing its de-dollarization program. And yet, here is the status of the US Dollar:

• The Bank of International Settlements (BIS) released its latest quarterly review in April 2024, which showed a sharp increase in the use of US dollars for international transactions and investments.

• Global demand for US dollar-denominated assets and transactions has risen significantly, driven by changing monetary policy expectations in the US and geopolitical tensions, especially in the Middle East

• The US dollar's share of global foreign exchange reserves held by central banks climbed to over 60% in early 2024, up from around 59% a year earlier.

• Cross-border lending and borrowing in US dollars also jumped, with outstanding US dollar-denominated credit to non-bank borrowers outside the US reaching a record high. 

In other words, as efforts to de-dollarize have accelerated, US Dollar usage has actually increased. The current macroeconomic circumstances are accentuating the dollar’s structurally-embedded dominance over its counterparts.

While inflation in the US has been deflating, the Fed’s crusade to rein in prices has tightened credit conditions globally and weakened growth prospects. As a result, risk appetite among investors has fallen, and demand for liquid, risk-free assets - such as Treasuries and the dollar itself - has risen. As far as treasuries go, the recent bond auction saw a bid-to-cover ratio of 2.67, the highest since Feb 2022.

It is in no country’s interest to rapidly move away from the US Dollar - even for rivals such as China and Russia. A sudden drop in the dollar’s value would leave a hole in the global financial system’s balance sheet and catalyze an unprecedented economic meltdown. It would be a Pyrrhic Victory at best. 

Strategic dedollarization efforts are therefore more of a gradual, secular trend resulting from the accumulated changes of a multilateral geo-financial strategy.

Having said all this, the US Dollar’s position in the global economy and financial ecosystem is sufficient enough to not warrant a sense of urgency. For this reason, Washington does not need to take overly proactive measures to pressure countries away from dedollarization efforts.

The current dollar-centric system is itself an enforcement mechanism. Countries looking to dedollarize their economies without gradual, multilateral efforts to support the transition would face high separation costs in the three key areas:

1. Cross border transaction 

2. Capital raising in a dollar-centric system

3. Reduced competitiveness of firms in foreign markets

Despite public alarm in Western media, the Chinese Yuan will not replace the dollar as the world’s reserve currency in the short-term, and is highly unlikely to do so in the long term. China has made it clear that it is not willing to open up its markets to the threshold necessary for establishing the Yuan (RMB) as a reserve currency.

The opaque dual currency system of an on and off-shore Renminbi (CNY, and CNH, respectively) further complicates global liquidity risks. Beijing’s capital controls make comprehensive deregulation a major threat to the country’s financial stability and could exacerbate underlying structural risks e.g. corporate debt levels, housing market fragility.

Furthermore, the PBoC has maintained a reference rate of between 6-7 yuan per dollar, and this semi-artificial range obscures what the actual value of RMB is on international markets.

China’s financial markets are also not deep or wide enough to accommodate massive capital influxes on the same scale as the US Dollar. In 2020 amid the panic of the COVID-19 outbreak, investors flocked to the Greenback, and Washington deployed trillions of dollars worth of relief packages.

While the dollar rose against its G10 and emerging market counterparts, its value in relative terms did not fluctuate to destabilizing levels. If RMB received equivalent capital inflows, the lack of liquidity combined with the underdeveloped market structure relative to the US would have produced unprecedented volatility in the Yuan. 

China can and has been exploiting the moral gap between the US and countries abroad who do not share the same liberal values, and inserting itself as a more viable, long-term partner.

The deterioration in Saudi-US relations and proportionate warming between Xi Jinping and Crown Prince Mohammed bin Salman Al Saud are an example. Not entirely by coincidence, it is here where China is exploiting a strategic weakness to accelerate its dedollarization efforts to undermine the dollar-priced commodity system.

Specifically, supplanting the petrodollar for the petroyuan to give US-sanctioned countries who are major oil exporters, such as Iran and Russia, access to global markets through non-dollar payments.

The appetite for a non-dollar paradigm therefore appears to be ripening: RMB oil futures contracts have now become more common than their Sterling-denominated counterparts, despite having zero market share five years ago. 

Reducing the use of the dollar in the multi-trillion dollar oil market alone would mark a trend-defining shift in US economic and political dynamics. Specifically, it would undermine the value of the dollar internationally by diluting the number of oil-related transactions denominated in USD.

In 2022, China imported just under $65 billion worth of oil from Saudi Arabia, marking a 32% increase since 2021. Dedollarizing this multi-billion dollar arrangement would mark a notable change in the petrodollar system - and therefore the perception of diminishing US geopolitical clout.

But looking at the bigger picture, the immediate threat is not imminent. If China and Saudi Arabia were to dedollarize their entire oil trading paradigm, it would constitute less than 1% of the total value of the $7 trillion, USD-denominated oil market.

In absolute terms, it is negligible and will therefore not negatively impact the US Dollar or require an official, diplomatic response from Washington.

Furthermore, US-Saudi relations were built on an “oil for security” paradigm that over the years has made the latter dependent on the former. Approximately 80% of Riyadh’s defensive and offensive hardware comes from the US and is required to maintain national security and regional stability vis-a-vis Iran.

Saudi Arabia would not risk going too far to anger its security guarantor that indirectly protects its borders and passageways for the Kingdom’s oil.It would also not be in Beijing’s economic interest to have a stronger currency.

China enjoys a trade surplus with the majority of its partners, and is the world’s largest exporter at over $3.59 trillion worth of goods sold in cross-border transactions in 2022.

A stronger Yuan would shrink China’s exports and therefore imperil a key source of the country’s growth. Over the last two years, goods sold abroad have been crucial to China’s growth amid a slump in consumer spending resulting from government-sanctioned COVID-19 lockdowns. The top-down nature of Beijing’s political modus operandi is also another reason why the Yuan will not likely become a reserve currency.

The top-down nature of governance in the Chinese political system and lack of regulatory transparency elevates policy risks, further prohibiting the Yuan from wearing the crown of reserve currency. 

While Beijing’s dedollarization efforts are worthy of note to US security officials, there are three related vulnerabilities within BRICS that Washington can exploit.

One: incongruent governance. There is significant ideological heterogeneity within BRICS, and that friction is preventing wider and deeper policy coordination. While Moscow and Beijing share a common enemy, tensions historically have been high even when both countries were communist states aligned against the same adversary. China is burdened by border disputes with India and Russia, and other members of BRICS do not share the same rivalrous tension Beijing does with Washington.

Two: a lack of intra-group economic dynamism. Trade between BRICS nations is smaller than the cross-border sales of the group’s individual members with the West. The bloc’s economies individually and collectively still rely more on North American and European markets than they do on each other.

Third: asymmetric funding. South Africa, and particularly Russia in light of the Ukraine war and crippling sanctions that followed, are experiencing internal currency tribulations. As the biggest economy in BRICS, the mantle then goes to China to provide the primary source of funding for expanding the bloc’s operations. But doing so would give Beijing disproportionate influence and would change BRICS’ dynamism from a bloc of equals to a China-plus-partners group.

This would exacerbate tensions from ideological rifts already-present within BRICS. Furthermore, the prioritization of BRI for Xi and its ongoing complications means there are limits to the resources Beijing can allocate to BRICS-related initiatives.

These are geopolitical/economic vulnerabilities the US can exploit by leveraging its deep financial and consumer markets as incentives to stay in the dollar-centric system. The benefits of participating in a dollar-led system acts as a natural economic deterrent for countries vulnerable to getting caught in China’s political-economic orbit.

More proactively, the US can address long-standing grievances of the IMF’s lending practices to developing countries. While BRICS collectively accounts for almost half of the world’s population and a quarter of global GDP, their joint voting power in the IMF is less than 15%.

As a result, they have little say in IMF lending policies and have created BRICS in response to this asymmetry. Reforming the IMF’s lending conditions to offer better funding arrangements could magnetize states to abandon or at least slow down dedollarizing efforts.

It is far easier for countries already participating in a dollar-centric system to push for internal reform than to abandon an efficient, liquid, and standardized global paradigm in favor of a BRICS alternative.