Is a Brics currency a viable reserve currency option? Not so fast.
14 Jul, 2023

Adriaan Pask, Chief Investment Officer at PSG Wealth

 

Over the past few weeks, there has been considerable discussion about a new Brics currency that could challenge the US dollar as the world’s reserve currency or, at the very least, provide an alternative. A shift away from the US dollar as the world’s reserve currency represents a significant realignment in geopolitical forces, which is assisted of course by talk that up to 80 countries are lining up to join the new currency.

 

The US dollar serves as the world’s reserve currency, primarily due to the petrodollar system, where oil transactions are conducted in dollars and the proceeds are reinvested in US bond and treasury markets. The reserve currency’s purpose is to facilitate efficient trade by providing a widely accepted medium of exchange and sufficient reserves for seamless transactions across regions. This efficiency also extends to investments and debt settlements.

 

For investors, the credibility and trustworthiness of the reserve currency are crucial factors. Currently, the US possesses a stable democratic system, a mature economy, robust governance, transparent fiscal and monetary policies, and a globally open trade environment. These attributes contribute to the trust placed in the US dollar.

 

In contrast, the Brics countries often lack these characteristics, making them distinct from the US in terms of stability, economic maturity, governance and openness to international trade.

 

Against this backdrop, there are predominantly two reasons driving the recent narrative of why emerging markets are thinking of replacing the US dollar.

 

The first reason is tensions between the US, China and Russia. The US and China tensions escalated significantly during the Trump administration, and obviously, recent developments in Ukraine have put tremendous strain on US and Russian relations. The latter resulted in sanctions that essentially cut Russia off from the global financial system, which is referred to as the so-called “weaponization” of the dollar. China also knows it would not be exempt were the tensions there to escalate.

 

The second reason would be a broader emerging-market impact. The relatively strong dollar over the last few years, in what’s been a risk-off environment, has put emerging economies under pressure. Importing goods becomes increasingly expensive if your currency is relatively weak and the offset that you get from exports has less of an impact. That then means that you are ultimately importing some inflation, which in turn leads to higher interest rates, which negatively impacts on growth.

 

Most emerging market countries also have significant amounts of dollar-denominated debt. In a higher interest rate environment, coupled with a firmer dollar, this debt becomes increasingly expensive to repay and these countries ultimately risk a potential default.

 

Despite the significance of these structural “pain points” for the Brics countries, it is important to note that deciding on and implementing a Brics reserve currency is very far from straightforward.

 

Implementing cross-regional policies introduces considerable complexity. The Brics countries exhibit notable variations in their policy deployment, GDP generation, currency management, interest rates, and inflation policies. Achieving the required level of integration would be exceedingly complex.

 

Furthermore, it is necessary to evaluate whether the effort invested in creating a Brics reserve currency is even worthwhile. One could simply opt to hold the individual Brics currencies as reserves if needed.

 

That being said, I think it’s a good discussion and debate to have because it forces the hand of some emerging markets to adopt more global investor-friendly policies.

 

China, for instance, faces certain constraints, despite its remarkable growth, such as governance and regulations which can be erratic, and the currency is not fully convertible yet. Refinement and improvement in these areas are necessary before it could even be considered a viable alternative.

 

The ultimate goal is to enhance transparency, convertibility, and integration into the financial system, and achieving these objectives would offer investors greater security and more options in high-growth environments. While this shift has the potential to be positive, successful implementation is key. Poor execution could lead to turbulence instead of the desired efficiency.

 

Currently 84% of the world’s trade is done in the US dollar, but that does not mean that it will remain the world’s reserve currency indefinitely. Financial development across the globe has paved the way for easier entry of alternatives, for example, the Euro has started to take a bigger share of global reserves since its introduction.

 

However, if you ask how realistic it is for a Brics currency to ultimately dethrone the dollar as the primary reserve currency? I think we’re still a very long way off from that.

 

ENDS

 

 

Author

@Adriaan Pask, PSG Wealth
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