DEDOLLARISATION - WHAT WILL BRICS DO?

This is a three-part post on the march towards dedollarisation. The first post looked at the motivations for dedollarisation. The second part looked at the geopolitics vs macroeconomics, and this concluding part is second guessing what BRICS+ new currency system will be. Details are scarce at the moment but BRICS+ had promised this coming October Summit an important announcement regarding the reserve currency will be announced. Before October arrives, let's look at some of the issues.

The original BRIC was founded in 2009 by Brazil, Russia, India and China. It became BRICS in 2010 when South Africa joined. Today it is BRICS+ when Iran, Egypt, Ethiopia and UAE joined in 2024. Argentina and Saudi Arabia were supposed to join this year. Argentina backed out under new President Javier Milieu, in keeping with his campaign promise. Saudis are reconsidering.

Objectives

The West likes to portray BRICS+ as a China-led group intend on pursuing anti-US agendas. The original BRIC announcements made it clear their purpose was economic cooperation and how they can be more involved in global affairs. In 2015 they set up New Development Bank with US$100b funding, which they say will cooperate with IMF and World Bank. NDF loans will not force conditions on borrowing states the way IMF and World bank do. In the same year, the Contingent Reserve Arrangement Fund with a pooled fund of US$100b was established to help member states in times of liquidity problems. The grouping has mentioned the need for a new global reserve currency. It has never mentioned the purpose was to attack the USD's position, but it is obvious their primary aim was to find ways to reduce reliance on the USD for their trades with each other.

The EURO model

The Euro bloc is a monetary union which means all member states replace their currencies with a single new currency and give up sovereignty over monetary policies to a central EU central bank. This model is impossible for BRICS for various reasons. A monetary union means a borderless movement of goods and people which will be a disaster as the flow will naturally be from the poorer states to the richer ones. It is impossible for a grouping of states with different ideologies, different styles of government, different levels of economic development, and multicultural, to achieve monetary union.

Use the major currency

"Two tigers cannot live in the same mountain"

Some call BRICS currencies the 5R's - Real, Ruble, Rupee, Renmenbi and Rand. The group could easily adopt one of the 'R" as the preferred currency to use with each other. If it comes down to that, Chinese RMB is the obvious choice in deference to the size of its economy. There is a problem. An old Chinese proverb says "Two tigers cannot live in the same mountain". With political history in the way, India will never allow the RMB to be used as the reserve currency for the bloc.

It is not just the use of a reserve currency, but the need for a new cross-border payment system parallel to SWIFT. The group has signed agreements for cooperation in information and communication technology development as well as a proposed undersea optical fibre cable for communications within the group to overcome US intelligence surveillance. Despite this, the 'two tigers' impasse caused the original BRIC countries to go separate ways to develope their own payment systems as back-up to SWIFT. Brazil has their Pix, Russia has SPFS (System for Transfer of Financial Messages), India has the SFMS (Structured Financial Messaging System, and China the CIPS (Cross-border Interbank Payment System)

The Triffin Dilemma

Should they select any of the 5R currencies, whether RMB or any other, the issuing country will suffer what is known as the Triffin Dilemma. To serve both the state and the global economy, a conflict of interest arises. The country's short term domestic monetary policies will clash with the long term economic objectives of the global economy. 

As a reserve currency, the issuing country needs to keep supplying the world with its currency. This means it needs to keep persistent trade deficits. The consequence is its domestic economy suffers with loss of production output, lost of jobs and increased national debt. All this in turn leads to loss of confidence in the currency by the international community.

This is exactly the situation the USD finds itself today. Should the RMB be used as the reserve currency by BRICS+, China will end up exactly like the US. It will take a longer time as the RMB will serve a smaller economy with the BRICS+ having an aggregate of only 30% share of world economy. But the Triffin dilemma will eventually visit China.

Will they create an entirely new currency?

They could retain existing national currencies but a create a new one for cross-border transactions amongst themselves. This idea has been proposed before. In 1944 when 50 countries gathered at Bretton Woods to discuss a new exchange system, renown economist John Maynard Keynes proposed using a new currency called Bancor. An importer will use his home currency to buy Bancor to pay the exporter. The purpose behind Bancor was to smoothen out the trade imbalances. The country that is a net exporter will accumulate more Bancor. Those with credit balances in Bancor will be charged an interest. This way, it forces the net exporting country to spend their Bancor away. Bancor was not accepted at Bretton Woods because it was complicated and the world's objective at the time was to speed up economic development.

In the case of BRICS+, the primary objective is merely to cut dependence on USD as the major currency for international trade. The bancor idea would be a Rube Goldberg machine, which is a contraption to make a simple solution unnecessarily complicated.

Would it be fiat currency or based on gold?

They could create a new currency like bancor but leave out the rebalancing of trade imbalances part. In which case, would be it fiat, or a gold system? Fiat means there is nothing to back the currency. All currencies in the world today are fiat.

If they want to use a currency backed by gold, they will end up just like the US in 1973. In order to support the huge amount of trade of all BRICS+ members, a massive amount of the reserve currency has to be issued over time, thus their need for gold increases.They will run out of gold.

If they create a new currency, how is the monetary policies going to be managed? Monetary policies refer to the management of the money supply and related values, ie interest rates and exchange values. This necessitates a separate and independent central bank, just as in the case of Euro. But without a monetary union, individual state monetary policies will conflict with the group 'central bank'.

Blockchain technology

BRICS+ have made some teasers publicly that it will be based on blockchain technology. That means it will be tokenised, i.e., a crypto-currency. Similar problems of monetary sovereignty and Triffin Dilemma remains, though not seen openly.

1. Centralised or decentralised?
A decentralised system comes with too much questions this blog cannot do justice to. However, this will be central bank issues, which by its nature would definitely be centralised platform. The same questions of who controls and manages the monetary policies, and state vs central system conflicts remain. How will tokens be issued?
2. Crypto currency or stable coin?
In order to maintain stability, the crypto tokens will be stable coins. This means the tokens will be backed by something. If it is backed by gold, the same problems as the US faced in 1973 when it ran out of gold to back the USD applies. If it is to be backed by currency, which currency? Most likely it will be by a basket of currencies. In which case, the Triffin Dilemma is ever present. The issuing countries of the backing currencies need to constantly supply the currencies needed by the bloc. Thus the need to run persistent trade deficits.
3. Central Bank Digital Currency
Even a CBDC needs price discovery to find its equilibrium in a free and open market. The ecosystem of a financial market needs time to develope - the derivatives, the investing and speculating markets, etc.

What has BRICS+ been doing about dedollarising

China has blazed its own trail for the use of RMB for cross-border payments between itself and other countries. It has completed many tasks to booster the eco-system necessary to promote the use of RMB internationally. These include bilateral swap agreements, which guarantees liquidity of RMB, with many BRICS+ countries and others . It has implemented CIPS payment system, had RMB-denominated oil prices quoted on several exchanges, RMB oil futures quoted in Shanghai International Energy Exchange, established offshore RMB hubs in several financial centres. It is actively working for more oil trades to be transacted in RMB. This has been very successful to the extent that there has been a significant increase in RMB settlements over SWIFT although it is still under 5% of global aggregate. However, slightly more than half of China's cross-border payments to and from the rest of the world is now in RMB. These payments are over CIPS and thus not captured in SWIFT data.

World reserve currency does not bother China anymore

No matter how much a currency is being used in the world, the amount of currencies to be held as reserves is the function of central banks. This explains why even though RMB is the second largest economy in the world and RMB settlements have increased tremendously, it still remains at a very low 2.15% of reserve currencies held globally in Q1 of 2024 (per IMF). Important considerations to central banks are the stability of currencies which is why non-traditional currencies have now found favour with central banks as they diversify their portfolio of foreign currency reserves to include AUD, CAD and others such as SGD. Another very important factor is the currency must have liquid capital markets for central banks to park their reserves. RMB is considered higher risk due to its issues with free convertibility, Chinese communist mindset, opaqueness and lesser developed capital markets. 

However, it matters not to China how much of RMB is held as reserves by the world. What matters is the usage of RMB in cross-border settlements which effectively lowers China's reliance on the USD.

China's foreign reserves in the past 10 years have dipped from US$3.9T in 2014 to about US$3.2T in 2024. This corresponds to a substantial decrease in US Treasury bill holdings in the period from US$1.3T in 2014 to US$0.98T in 2023. Many reason have been proposed by many experts, but I see clearly the relationship to China's success in getting countries that trade with them to use RMB. As China becomes less dependent on USD and can trade in its own currency, the need to hold USD reserves decreases. The decrease in holding USD reserves allows China to shave off holdings in US Treasury bills, thus lower their US exposure.

As a matter of fact, China must be the wise old man laughing in the room. It has persuaded much of the world to use RMB but does not suffer having its currency held up as reserves by other countries.

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