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The world of finance and economics has been watching the rise of the BRICS (Brazil, Russia, India, China, and South Africa) as a formidable economic power.
And this week, we saw the BRICS summit, held annually in Johannesburg, stealing the global economic spotlight.
The bloc welcomed 40 heads of state from nations eager to join its ranks.
The reason? Because they view BRICS as a compelling alternative to Western-dominated economic blocs.
The coalition discussed expanding its horizons, extending invitations to 6 new countries, including Argentina, Egypt, Ethiopia, Saudi Arabia, and the United Arab Emirates.
And come January 1, 2024, this newly expanded bloc will account for a staggering 46% of the world’s population and 37% of global gross domestic product (GDP) in terms of purchasing power.
But that’s not all; the bloc also has something bigger up its sleeve – reducing its reliance on the US dollar in favor of their own currencies, a move known as “de-dollarization.” (It’s a potential trading opportunity – click HERE to know more)
Now, experts speculate that with their combined population, GDP, and gold reserves, the BRICS could challenge the long-standing supremacy of the U.S. dollar as the world’s reserve currency.
The growing influence of the BRICS has prompted many countries and market pundits to discuss the concept of de-dollarization and its potential impact on the U.S. and the global economy.
Let’s understand the whole story with the help of some data and delve into the world of reserve currency and international trade.
Dollar’s Reserve Currency Status
Despite growing concerns about the BRICS challenging the dollar’s status as the world’s reserve currency, the dollar still remains the preferred currency for international transactions due to several reasons.
Firstly, the U.S. economy is the largest and strongest in the world, with a gross domestic product (GDP) much larger than other major economies, making it an attractive investment destination.
Secondly, the dollar’s wide acceptance across the globe plays a critical role in its dominance. About half of international trade is invoiced in dollars, and approximately 50% of global debt securities and international loans are denominated in dollars. In foreign exchange markets, the dollar is involved in nearly 90% of all transactions.
Moreover, the dollar’s credibility is reinforced by the United States’ military strength, legal, and political stability.
However, despite the dollar’s stability, several governments are reducing their dependency on it, mainly due to political disputes and financial crises.
Interestingly, the dollar’s reserve currency status has its roots in the aftermath of World War II, where the U.S. emerged stronger than its European counterparts, leading to significant gold inflows into the country.
But it wasn’t until 1944 that the dollar became a superpower when 44 countries signed the Bretton Woods Agreement to create a collective international currency exchange regime.
This was pegged to the dollar, and the dollar’s price was again pegged to the price of gold.
So, while the dollar remains the world’s reserve currency, why are countries looking for ways to reduce their dependence on it?
Mainly due to political disputes and geopolitical and economic uncertainties.
How has this been going?
BRICS and China’s Move Towards De-Dollarization
China and Brazil announced that they will use their national currencies for bilateral trade, rather than the US dollar.
The deal will enable China and Brazil to carry out trade and financial transactions directly, exchanging yuan for reais or reais for yuan, rather than first converting their currencies to the U.S. dollar.
Now, China is Brazil’s largest trading partner. It accounts for more than a fifth of all imports, followed by the U.S. It’s also Brazil’s largest export market. So, this move by two large economies suggests that countries are looking to diversify away from dollars.
In fact, the decline of U.S. dollar reserves has been continuing for the past two decades and major countries are looking for alternatives for a reserve currency, according to a recent IMF report.
In addition, the BRICS countries are also considering the idea of a common currency as a way to challenge the dominance of the U.S. dollar.
So, if countries are using other currencies to trade and conduct business, the dollar is bound to be doomed right?
It’s not that simple!
The Case for the U.S. Dollar
The idea of de-dollarization is getting a lot of steam in the media these days. It’s nothing but the idea of substituting the U.S. dollar as the currency used for trading commodities and other goods and services.
This is stirring up a lot of fear that the China and BRICS nations could shake up the world economic stage.
However, the dollar has been the reserve currency for decades and has built up its credibility over time.
It has proven to be a safe haven currency during times of economic downturn, such as the global financial crisis of 2008-2009 and the economic turmoil caused by the pandemic in 2020, during which investors sought out U.S. dollars expecting them to retain their value.
And in both these crises, the U.S. Fed adopted monetary authorities and currency swap lines with other central banks to provide liquidity and dollars.
Around 60% of the world’s central bank reserves are held in dollars.
Lastly, there are several reasons why the decline of the US dollar as the dominant reserve currency may not be imminent.
Despite the fact that other countries are increasingly using other currencies for trade, the U.S. remains the world’s largest economy and it has the deepest, most flexible financial markets and innovation at large.
Additionally, the US has the largest military budget in the world and the military power to defend its position as the global reserve currency.
Finally, the US dollar index (DXY) has shown continued growth against other currencies in recent years, suggesting ongoing demand for the greenback.
All this points to the fact that the U.S. dollar’s monopoly is hard to break and while governments are moving away from the greenback, their currencies are weakening at a faster clip than the dollar.
These developments are in fact leading us to what’s happening in the world economy today.
That being said, the increasing diversification away from the dollar could lead to increased volatility in the Forex markets, and investors should keep a close eye on these developments.
Discover how our seasoned analysts are making sense of this shift for potentially profitable trades – click HERE!
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