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The dollar is our currency, but it’s your problem

In late August, South Africa hosted a productive three-day BRICS summit. Perhaps the biggest policy announcement to come out of that summit was an agreement to invite into the bloc, effective January 2024, six new members—Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the UAE. De-dollarisation was another notable point of discussion during the summit that garnered global attention. I’d like to take this opportunity to discuss the issue of de-dollarisation, drawing from our latest analysis report at the EIU. The discussion is particularly relevant in light of the dissatisfaction expressed by BRICS countries with the US-dollar-dominated international financial system. During the summit, Brazil’s president, Luiz Inácio Lula da Silva, and his South African counterpart, Cyril Ramaphosa, advocated the use of individual countries’ currencies for settling trade. Mr Ramaphosa also called out the “weaponisation” of the global financial system. Newly approved BRICS members are also frustrated by the current system; Argentina recently settled an IMF obligation in renminbi after facing persistent US dollar shortages, and Iran has faced US-led international sanctions for many years. The support for alternatives to US dollar international settlement has veered into hyperbole. Russian officials, most recently foreign minister Sergei Lavrov, have said that BRICS would discuss developing a new currency—an infeasible idea. Nonetheless, remarks on the topic by new and current BRICs members highlight frustrations at the threat of or necessity to abide by US sanctions and the overwhelming influence of the Federal Reserve (the US central bank) on international liquidity.

The 2023 summit’s closing declaration reflected members’ desires for an adapted or alternative system. The statement encourages the development of international settlement via local currencies and strengthening of correspondent banking networks (established systems for cross-border commercial bank-to-bank transfers). It also highlights the interlinking of cross-border payment systems as an area for members to explore.

Behind all these aspirations, China’s presence looms large. The renminbi would be a top candidate among BRICS to fill the alternative international currency role. China’s economy is the largest in the group and the main trading partner of most other BRICS members. Circulation of the renminbi among emerging markets has been growing via a network of central bank currency swap arrangements and foreign lending by Chinese state-owned banks, which complements the rising share of China’s trade settled in its local currency. Concurrently, China is developing its own system for international transfers in the form of the Cross-Border Inter­bank Payment System (CIPS), an already active but infrequently used alternative to EU-headquartered SWIFT.

International uptake of the renminbi, however, is fundamentally constrained by its limited convertibility. Global liquidity of the renminbi is in turn limited by China’s capital controls, which also negate much of the potential contribution that a much-publicised central bank digital currency could make to internationalisation. Even if China were to reduce capital controls significantly (a highly unlikely scenario in 2023-27), the dominance of US financial markets and current global pattern of external account imbalances would prevent renminbi internationalisation to the extent of non-US reserve currencies, such as the euro. Deep and open financial markets in the US, combined with a trend of US current-account deficits and emerging-market surpluses, draw in capital that supports the US dollar. This is much of the basis for the pricing of oil in US dollars (“petrodollar” proceeds that are invested in US dollar-denominated assets) and helps to explain China’s large holdings of US public debt instruments.

As such, a loss of US dollar primacy or the establishment of a parallel system would require structural changes to several large economies via major shifts in domestic economic policy, which could only fully occur well beyond our forecast period. In our view, Chinese policymakers, along with other BRICS governments, are undoubtedly aware of this and will instead be aiming to establish less comprehensive options to blunt US-led sanctions and lessen reliance on US dollar financing and liquidity.

In fact, grievances against the US-dollar-dominated international financial system have long been a recurring issue in the international community. The recently formed BRICS+ is far from the first organization aiming to challenge the dollar’s currency status. If we briefly review history, even Americans themselves have recognized the dollar as a “problem” for other nations. As far back as the 1971 G10 Rome meetings, during the Nixon administration, then-Treasury Secretary John Connally shocked the world when, after discussions with a group of European finance ministers, he famously remarked, “The dollar is our currency, but it’s your problem.”

The paradox here is that despite the international community’s recognition that the dominance of the dollar in the financial system could potentially be wielded as a political weapon, reliance on the dollar has not diminished since the US abandoned the gold standard in August 1971. Furthermore, a new currency capable of truly replacing the dollar as the world’s primary reserve and exchange currency has yet to emerge. Even though the birth of the euro in 1999 briefly provided a new option for the international financial system, the lack of a unified European fiscal department meant that the euro still couldn’t rival the depth and liquidity of the dollar.

As a result, operating outside the US-dollar dominated international financial system will remain a riskier and costlier proposition for many years, so will continue to be exceptional practice. Having said that, the direction of travel will be a growing cause for concern to the US and its allies, with calls for the US to act more prudently in applying its international financial tools, both for punishing bad actors and preserving the current status quo. This will mean applying comprehensive sanctions more sparingly, increasing the number of US dollar currency swaps offered, and ensuring that the denomination of multilateral concessional flows to states remains tilted to the currencies of the US and its allies in as many cases as possible.

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