We don’t like to brag here at The European Conservative, but we do like to point out when we were first with, and right about, something.
Next week, 69 countries are invited to participate in the 2023 summit for the BRICS group in South Africa. One of the issues expected to be on their agenda is the creation of some kind of independent currency system for international trade.
Many commentators around the internet have centered on this idea, which would allow trade between multiple countries without any reliance on the U.S. dollar. This, of course, is an implied threat to the dollar’s global hegemony. As such, it carries great news value and has therefore attracted internet pundits of all qualities, who are eager to add their two (de-dollarized) cents’ worth of commentary on the issue.
All too often, such comments are characterized by high pitches, bold but unsubstantiated statements, and pure hype. A lot of that would have been unnecessary if those commentators had read my article from July last year, where I explained this new de-dollarized currency system.
In April this year, our own Robert Semonsen wrote two articles on this subject. Later in the spring, I published a two-part analysis of the relationship between the U.S. government’s insatiable appetite for new debt and how it aggravates the consequences of the de-dollarization trend.
In other words, The European Conservative has not only been ahead of the curve on this issue, but we have also provided substantive reporting and measured analysis. Given the high tone of assorted pundits on this potential threat to the dollar, we are happy to stand firm in providing value for the time our readers give us.
Here is a representative example of the hyperbole in the BRICS vs. dollar debate:
The gold-backed BRICS currency threatens to obliterate the foundation of ‘fiat’ currencies. Foremost among these is the US dollar, the de facto global reserve currency. … If nations switch their foreign trade dealings to the gold-backed BRICS currency, a tidal wave of US dollars would return to American shores, causing inflation to spike in unprecedented ways.
The author in question offers no explanation of how inflation would ‘spike in unprecedented ways’, but it all sounds doomsday-ish, does it not? The problem is that the numbers are not on this writer’s side: even if the ten most important BRICS countries, led by China, Russia, India, and Brazil, sold off every dollar they had in their central-bank reserves, it would cause a monetary expansion of about one-third of what the United States experienced during the Covid pandemic.
This is still a significant monetary expansion, and we have all the reasons in the world to believe that it will cause a sharp rise in inflation. However, to claim that this would be ‘unprecedented’ is to mistake bombastic language for solid facts.
The pundit in question, Medeea Greere with amg-news.com, also makes another mistake, one that is frequent among those commenting on the BRICS vs. dollar issue. She suggests that the mere switch of “foreign trade dealings to the gold-backed BRICS currency” will leave U.S. currency unused. However, even though trade is often denominated in dollars, it does not necessitate the actual use of dollars to clear every trade. The only necessary condition for the dollar denomination of global trade is that prices are contracted in dollars, and that the dollar is a default payment method.
If I export wood-carved figures from Sweden to Kazakhstan and set the price per figure to $10, then I can demand of the Kazakh importer that he pays me in dollars, or I can request that he compensate me in another currency at an amount exactly equal to $10. The Kazakh importer can pay me in his own tenge or in my Swedish krona—unless I demand to get paid explicitly in dollars, the U.S. currency will play a role only as the unit of measure.
Many trade deals do, of course, involve actual dollar payments. However, without knowing the exact share of where such transactions take place vs. those where prices are simply expressed in dollars, it is rash to suggest that the introduction of another currency for the pricing of trade, would automatically lead to a tsunami of dollars hitting U.S. shores.
With that said, there is one undeniable source of a dollar tsunami: central banks selling off their dollar reserves. As mentioned earlier, a substantial sell-off of the U.S. currency by the ten most important central banks in BRICS would lead to a significant but not catastrophic surge in the U.S. money supply.
That does not mean the effects of such a surge would not be serious; for reasons to be discussed at another time, the U.S. economy is more sensitive to inflation now than it was before the pandemic. But it means that pundits who opine on the matter should avoid exaggerated language; all it does is make it harder to have a measured conversation on this issue. We need a measured conversation: the future status of the dollar is one of the most important economic and financial questions of our time.
Another aspect of the BRICS currency plans is its likely base in gold. Conservatives have a strong preference for the gold standard; while I do respect their desire that every nation has its own strong currency, it is essential to be pragmatic about the gold standard and see both its merits and its under-appreciated limitations.
In particular, it is important not to get carried away by the idea that a BRICS alternative to the dollar would be based on gold. While, again, many commentators are seduced by their own preference for the gold standard, there are more balanced views out there. One of them is Nathan Lewis with Forbes. On July 16th he provided a short but valuable historic review of what the BRICS countries are trying to accomplish. Focusing on the trade part of their ambitions, rather than the currency part, Lewis notes that if the BRICS countries did create a gold-based system where trade between their nations can be denominated in another currency than the dollar, it would replicate some key elements from the Bretton Woods currency system that was in effect from 1944 to 1971.
Explains Lewis:
The centerpiece was the US dollar, which in turn would be linked to gold at $35/oz., its gold parity since 1933. This laid the foundation for two decades of peace, prosperity, and fixed exchange rates
All the currencies that participated in the Bretton Woods system were pegged directly to the dollar and therefore indirectly to gold.
The comparison to Bretton Woods is good, because it gives us an idea of what a gold-based trade currency would look like. It would not be a formal currency, but rather a system of fixed exchange rates with a gold-pegged anchor currency.
Lewis suggests that a Bretton-Woods style BRICS system—BRICS BW—would rely on the Chinese currency, the yuan, as its anchor. This in turn would require the Chinese government to peg its currency to gold—and keep it there for the foreseeable future.
I am inclined to agree with Nathan Lewis that this is the most likely scenario of what is going to come out of the BRICS summit, although technically the Chinese would use the renminbi—the Chinese trade currency—for their participation in this system. The difference may seem merely technical, but as we will see in a coming article, it can have substantive consequences for the system which of these two currencies the Chinese decide to use.
I would also expect the BRICS BW to have two other features. First, it would be accompanied by a banking system that is independent of the U.S.-based SWIFT system. Ever since the U.S. government ramped up its sanctions against Russia and kicked them out of SWIFT in retaliation for the Russian invasion of Ukraine, the Russians have worked tirelessly on creating their own banking infrastructure. It is reasonable to expect that BRICS countries that join the BRICS BW will also join this alternative system for the clearing of international bank transactions.
Secondly, a BRICS BW would be accompanied by the RLA system I wrote about last year. This is the Renminbi Liquidity Arrangement that the Chinese government created and got approved last year by the Bank for International Settlements. The goal of this system, I explained, is to allow central banks to quit using the dollar:
The RLA will provide liquidity security for participating central banks; the security of the system will ultimately be anchored by China, which means that its [currency] will be the reserve currency of the system.
This means, in a nutshell, that when central banks that participate in a BRICS BW need to perform major payments but are short on liquidity for the purpose, they can turn to the Bank of China for a renminbi-denominated line of credit.
This function of the RLA can become significant under a BRICS BW: with fixed exchange rates for their individual currencies, the participating central banks will need to make frequent (as in daily) market operations in order to make sure their currency does not depreciate or appreciate its way out of the system. This can easily put a central bank under short-term liquidity stress, at which point it draws funds from its Chinese line of credit.
In short, the upcoming BRICS summit on August 22-24 will probably not
- Mark the beginning of the swift end of the dollar;
- Destroy fiat currencies in short order; or
- Send tsunamis of dollars onto America’s shores.
Instead, it will probably
- Mark the beginning of an exchange-rate system, a BRICS BW, with at least the key BRICS nations participating;
- Officially introduce a clearing system for international bank transactions to allow countries to leave SWIFT; and
- Present the already-operating Renminbi Liquidity Arrangement as a Chinese-anchored system for the exchange-rate system and for central bank liquidity and currency reserves.
Once these institutions are in place, it is an open question how far it will carry its participating countries in terms of economic growth and financial stability. While it is correct, as Nathan Lewis does, to credit the Bretton Woods system for some of the economic success of North America and Western Europe in the 1950s and 1960s, it is important not to exaggerate the role of fixed exchange rates. A fixed exchange rate is after all a government price regulation; the free market is fairly good at pricing things for what they are worth.
The real question for the BRICS nations that join a new exchange-rate system will be whether or not the Chinese government can keep its anchor promise. If the Bank of China is pressured by domestic policy needs into printing more money than the exchange-rate gold peg can handle, then the system will be no more successful than the Bretton Woods system was.
If I were to make one prediction (given that I have not actually seen the system that the BRICS nations might create) it would be that the Chinese are biting off more than they can chew. Their own economy is in rough shape—an issue we will have to return to—to a point where it may be tempting for the government in Beijing to save it by printing money.
More on this next week.
