Brics update: Uncovering the de-dollarization conspiracy

BRICS has been gaining notoriety over the last few months, with various conspiracies emerging. One popular theory circulating is that Russia and China are scheming to dethrone the dollar and send the US economy into a nosedive. The lack of major announcements at the most recent BRICS conference may continue to fuel that conspiracy, but the information void itself also reveals another possible outcome.

Is USD on its way out? Maybe, but not in the way a doom-and-gloom article might suggest.

BRICS: more than just a counterweight to Western powers

The addition of Argentina, Egypt, Iran, Ethiopia, Saudi Arabia, and the United Arab Emirates to the BRICS bloc dynamic could be seen as a reaction to decades of Western dominance over global governance and finance. The growing desire for alternatives to the US dollar is attracting many nations toward a diversified approach to international trade and currency reserves. 

Commodity trading between nations using alternative currencies may well increase in the coming months and years, which means less demand for USD reserves, but that doesn’t mean the end of the dollar as international legal tender.

Diverse paths to USD alternatives

Cracks in the US’ financial pillars are beginning to show as other currencies shuffle towards center stage, but this is not cause for anticipating total de-dollarization. In reality, a unified BRICS currency is less than feasible, due to the diversity of the economies within the group. The use of gold as a peg for a new currency, and even the use of blockchain technology, have been mentioned as potential strategies, although currently considered more long-term options, which is why such announcements were not made at the BRICS summit in August. Instead, alternative strategies are being studied.

One approach is the greater use of local currencies in trade settlements, as evidenced by Russia and China's transactions in rubles and yuan. However, this poses challenges around currency convertibility and the creation of alternative clearance systems. The trend toward diversification and de-dollarization is unmistakable, but the logistics of creating a fair and equitable currency for all BRICS members is a mammoth task.

Moreover, some BRICS members are not allied in other geopolitical aspects, which may present a long-term source of discord and delay advances. Add to that six new members, each bringing their own economics and demands.

For now, the goal of the BRICS movement is not necessarily to replace the dollar, but to provide the world with a stable option where no single country’s currency holds undue influence over other nations — which is a very good thing.

Why de-dollarization won’t happen overnight

One de-dollarization theory suggests that the BRICS bloc could try to instigate a dollar collapse simply by repatriating their USD reserves in return for their own currencies and gold. The foreign exchange reserves of the top 13 highest-holding countries is a staggering $12 trillion. Now consider that the US Treasury holds around 261.5 million troy ounces of gold, the vast majority of which is in bullion. 261,500,000 troy ounces at the price of $1,941/ounce is $507.6 billion.

If BRICS started to sell back their US dollar reserves all at once, the US Treasury would be empty after covering only 10% and the country would go bankrupt overnight. The math holds up, but it’s naive to believe such a scenario could ever happen.

The US would likely not honor any of those agreements. Instead, the world would probably see a press conference similar to that of the 1971 ‘Nixon Shock’, when US President Richard Nixon announced the suspension of the dollar's convertibility into gold. If the bloc made such an aggressive move against the US, all nations would still be stuck with their USD, with the choice to use it or store it, but definitely not to sell it.

Would a US default end the international dollar?

If the US defaults on its international obligations, it’s still not the end of USD. Following the brutal 1971 announcement, there was an immediate disruption in global financial markets, but surprisingly very little blowback for the US. Currencies that were pegged to USD had to be revalued or allowed to float freely. With the collapse of the gold standard, most major currencies transitioned to floating exchange rates. This meant that the value of currencies would be determined by supply and demand in the foreign exchange market.

In the years following the end of the gold standard, many countries experienced inflation and devaluation of their currencies. The dollar itself faced inflationary pressures during this period, but it did not break the US.

Conclusion

For now, the dollar remains resilient. No nation will willingly devalue a currency it holds in the billions. Moreover, a bankrupt US is not good for the wider global economy. Total and rapid de-dollarization would likely lead to a global recession like no other. But that doesn’t mean de-dollarization is just a myth. Russian President Vladimir Putin said that the process of de-dollarization is "irreversible" and "gaining pace." Countries can gradually and safely reduce their USD holdings over time. In fact, it has already begun. Last year, the global share of US dollars held by central banks fell to 59% - its lowest in 25 years - compared to the previous year's 71%.

One could speculate that, as billions in USD continue to return home, the Fed would be forced to raise interest rates, but fewer nations would buy the growing debt. US inflation would continue to rise as the currency devalues. Prolonged high interest rates could erode US industries over time, and the US stock market might feel the pinch.

Eventually, the Fed would have to lower interest rates, accept the devaluation, and start focusing on rebuilding the US economy within the new paradigm. Something similar to what Greece went through in 2012. On the trading charts, USD would fall into a long and slow decline against major currencies, and countries such as China and Japan would probably leverage the opportunity to overtake the US in technological dominance, negatively affecting US tech stock prices.

The US has been surviving thus far on borrowed time and borrowed money, but will eventually have to face reality. The price of making America the self-styled “greatest country in the world” for several decades is high, and payment is due. Of course, this is all speculation, remember: just one version of a possible future. War or new alliances — there are different roads the US might take, each with different destinations and different financial outcomes. As a trader, think globally, plan long-term, then ride the waves of short-term volatility as we move into the future. If the financial world accepts that the US is broke, investors will abandon USD. The most likely alternatives to the dollar are metals and possibly even digital currencies. The migration will start to slow, then regain momentum. Look for early signs, and view every economic report with a critical eye.