The Coming Shock to the Global Monetary System
On Aug. 22, about 2½ months from today, the most significant development in international finance since 1971 will be unveiled.
It involves the rollout of a major new currency that could weaken the role of the dollar in global payments and ultimately displace the U.S. dollar as the leading payment currency and reserve currency.
It could happen in just a few years.
The process by which this will happen is unprecedented, and the world is unprepared for this geopolitical shock wave.
This monetary shock will be delivered by a group called the BRICS.
The acronym BRICS stands for Brazil, Russia, India, China and South Africa.
This play for global reserve currency status by the BRICS will affect world trade, direct foreign investment and investor portfolios in dramatic and unforeseen ways.
The most important development in the BRICS system concerns the expansion of BRICS membership. This has led to the informal adoption of the name BRICS+ for the expanded organization.
There are currently eight nations that have formally applied for membership and 17 others that have expressed interest in joining. The eight formal applicants are: Algeria, Argentina, Bahrain, Egypt, Indonesia, Iran, Saudi Arabia and the United Arab Emirates.
The 17 countries that have expressed interest are: Afghanistan, Bangladesh, Belarus, Kazakhstan, Mexico, Nicaragua, Nigeria, Pakistan, Senegal, Sudan, Syria, Thailand, Tunisia, Turkey, Uruguay, Venezuela and Zimbabwe.
There’s more to this list than just increasing the headcount at future BRICS meetings.
If Saudi Arabia and Russia are both members, you have two of the three largest energy producers in the world under one tent (the U.S. is the other member of the energy Big Three).
If Russia, China, Brazil and India are all members, you have four of the seven largest countries in the world measured by landmass possessing 30% of the Earth’s dry surface and related natural resources.
Almost 50% of the world’s wheat and rice production as well as 15% of the world’s gold reserves are in the BRICS.
Meanwhile, China, India, Brazil and Russia are four of the nine highest-population countries on the planet with a combined population of 3.2 billion people or 40% of the Earth’s population.
China, India, Brazil, Russia and Saudi Arabia have a combined GDP of $29 trillion or 28% of nominal global GDP. If one uses purchasing power parity to measure GDP, then the BRICS share is over 54%. Russia and China have two of the three largest nuclear arsenals in the world (the other leader is the United States).
By every measure — population, landmass, energy output, GDP, food output and nuclear weapons — BRICS is not just another multilateral debating society. They are a substantial and credible alternative to Western hegemony.
BRICS acting together is one pole of a new multipolar or even bipolar world.
When the new currency launch is announced in August, the currency will not fall on an empty field. It will fall into a sophisticated network of capital and communications. This network will greatly enhance its chances of success.
The BRICS are also developing an optical fiber submarine telecommunications system that would connect its members. It is being developed under the name BRICS Cable. Part of the motivation for BRICS Cable is to foil spying by the U.S. National Security Agency on message traffic carried through existing cable networks.
What’s behind this quest to ditch the dollar? In no small part the answer is U.S. weaponization of the dollar through the use of sanctions.
On numerous occasions from 2007–2014, I warned U.S. officials from the Treasury, Pentagon and intelligence community that overuse or abuse of dollar sanctions would lead adversaries to abandon the dollar to avoid the impact of sanctions.
Such abandonment would lead to the diluted potency of sanctions, unforeseen costs imposed on the U.S. and eventually to the collapse of confidence in the dollar itself. These warnings were mostly ignored.
We have now reached the first and second stages of this forecast and are dangerously close to the third.
For years, the U.S. has used sanctions to punish nations like Iran. But the sanctions the U.S. and its allies imposed on Russia after it invaded Ukraine last year went far beyond previous sanctions regimes. They were unprecedented.
Many other nations began to conclude that they could be next if they run afoul of the U.S. on certain issues. And that fear has greatly accelerated the push to opt out of the dollar system entirely.
This desire is not limited to current targets such as Russia but is shared by potential targets including China, Iran, Turkey, Saudi Arabia, Argentina and many others.
The BRICS+ present a realistic effort to de-dollarize global payments and eventually global reserves.
For years, I’ve argued that the dollar would remain the world’s leading reserve currency for longer than most people think.
But below, I show you why a new BRICS+ currency could greatly accelerate the demise of the dollar as the world’s leading reserve currency.
How could it happen so much faster than I previously thought? Read on.
The global desire to move away from the dollar as a medium of exchange for international trade in goods and services is hardly new. The difference today is that it’s gone from a discussion point to a novelty to a looming reality in a remarkably short period of time.
Dubai and China have recently concluded an arrangement whereby Dubai will accept Chinese yuan in payment for oil exports from Dubai. In turn, Dubai can use the yuan to buy semiconductors or manufactured goods from China.
Saudi Arabia and China have been discussing similar oil-for-yuan arrangements but nothing definitive has yet been put in place. These discussions are made complicated by Saudi Arabia’s long-standing petrodollar deal with the U.S. Still, some progress along these lines is widely expected.
China and Brazil have recently reached a broad-based bilateral currency deal where each country accepts the currency of the other in trade. Meanwhile, there’s a growing strategic relationship between China and Russia as the two superpowers jointly confront the United States. In the trading relationship between the two nations, Russia can pay in rubles for Chinese manufactured goods and other exports while China pays in yuan for Russian energy, strategic metals and weapons systems.
Yet all these arrangements may soon be superseded by a new BRICS+ currency, which will be announced in Durban, South Africa, at the annual BRICS Leaders’ Summit Conference on Aug. 22–24.
The currency will be pegged to a basket of commodities for use in trade among members. Initially, the BRICS+ commodity basket would include oil, wheat, copper and other essential goods traded globally in specified quantities.
In all likelihood, the new BRICS+ currency would not be available in the form of paper notes for use in everyday transactions. It would be a digital currency on a permissioned ledger maintained by a new BRICS+ financial institution with encrypted message traffic to record payments due or owing by participating parties. (This is not a cryptocurrency because it is not decentralized, not maintained on a blockchain and not open to all parties without approval.)
The latest information from the BRICS working groups is that this basket valuation methodology is encountering the same problems that John Maynard Keynes encountered at the Bretton Woods meetings in 1944.
Keynes initially suggested a basket of commodities approach for a world currency he called the bancor. The difficulty is that global commodities included in any basket are not entirely fungible (there are over 70 grades of crude oil distinguished by viscosity and sulfur content among other attributes).
In the end, Keynes saw that a basket of commodities is not necessary and that a single commodity — gold — would better serve the purpose of anchoring a currency for reasons of convenience and uniformity.
Based on the impracticality of commodity baskets as uniform stores of value, it appears likely that the new BRICS+ currency will be linked to a weight of gold.
This plays to the strengths of BRICS members Russia and China, who are the two largest gold producers in the world and are ranked sixth and seventh respectively among the 100 nations with gold reserves.
These and related developments are frequently touted as the “end of the dollar as a reserve currency.” Such comments reveal a lack of understanding as to how the international monetary and currency systems actually work.
The key mistake in almost all such analyses is a failure to distinguish between the respective roles of a payment currency and a reserve currency. Payment currencies are used in trade for goods and services. Nations can trade in whatever payment currency they want — it doesn’t have to be dollars.
Reserve currencies (so-called) are different. They’re essentially the savings accounts of sovereign nations that have earned them through trade surpluses. These balances are not held in currency form but in the form of securities.
When analysts say the dollar is the leading reserve currency, what they actually mean is that countries hold their reserves in securities denominated in a specific currency. For 60% of global reserves, those holdings are U.S. Treasury securities denominated in dollars. The reserves are not actually in dollars; they’re in securities.
As a result, you cannot be a reserve currency without a large, well-developed sovereign bond market. No country in the world comes close to the U.S. Treasury market in terms of size, variety of maturities, liquidity, settlement, derivatives and other necessary features.
So the real impediment to another currency as a reserve currency is the absence of a bond market where reserves are actually invested. That’s why it’s so difficult to displace Treasuries as reserve assets even if you wanted. Again, no country in the world can come close to the U.S. in that regard.
But here’s where it gets interesting, and why the dollar could lose its leading reserve status much faster than previously thought.
That’s because the BRICS+ currency offers the opportunity to leapfrog the Treasury market and create a deep, liquid bond market that could challenge Treasuries on the world stage almost from thin air.
The key is to create a BRICS+ currency bond market in 20 or more countries at once, relying on retail investors in each country to buy the bonds.
The BRICS+ bonds would be offered through banks and postal offices and other retail outlets. They would be denominated in BRICS+ currency but investors could purchase them in local currency at market-based exchange rates.
Since the currency is gold backed it would offer an attractive store of value compared with inflation- or default-prone local instruments in countries like Brazil or Argentina. The Chinese in particular would find such investments attractive since they are largely banned from foreign markets and are overinvested in real estate and domestic stocks.
It will take time for such a market to appeal to institutional investors, but the sheer volume of retail investing in BRICS+-denominated instruments in India, China, Brazil and Russia and other countries at the same time could absorb surpluses generated through world trade in the BRICS+ currency.
In short, the way to create an instant reserve currency is to create an instant bond market using your own citizens as willing buyers.
The U.S. did something similar in 1917. From 1790–1917, the U.S. bond market was for professionals only. There was no retail market. That changed during World War I when Woodrow Wilson authorized Liberty Bonds to help finance the war.
There were bond rallies and Liberty Bond parades in every major city. It became a patriotic duty to buy Liberty Bonds. The effort worked, and it also transformed finance. It was the beginning of a world where everyday Americans began to buy stocks, bonds and securities as retail investors.
If the BRICS+ use a kind of Liberty Bond patriotic model, they may well be able to create international reserve assets denominated in the BRICS+ currency even in the absence of developed market support.
This entire turn of events — introduction of a new gold-backed currency, rapid adoption as a payment currency and gradual use as a reserve asset currency — will begin on Aug. 22, 2023, after years of development.
Except for direct participants, the world has mostly ignored this prospect. The result will be an upheaval of the international monetary system coming in a matter of weeks.
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