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The BRICS nations, consisting of Brazil, Russia, India, China, and South Africa, are aiming at the creation of a common currency to compete with the US Dollar. But how realistic is this project – Let’s get after it!
To start with and historically speaking, a dominant currency stays in power for quite some time, i.e. a century or even more. The last major move started to phase in after WWII, with the preeminence of the GBP getting challenged after WWI. The transfer of supremacy occurred on the fact that trade became more and more US-centric and foreign direct investment amplified it.
In the nineties, the launch of the EURO was considered a real challenge by the US Administration. Today, the much-discussed introduction of the BRICS CCY, details of which are unclear as of now, seems to cause some doubts. We believe that in the short term, the possible construct appears to be an opportunistic development. Can the BRIC CCY become an immediate threat to the USD dominance, probably not, but things are not impossible. Remember, with the present settings, the USD accounts for about 90 % of all currency trading and nearly 100 % of oil trading.
Central to the present frustration within BRICS countries is that almost all is somehow related to US governance. For instance, a company that helps trade petrol sourced by a non-cooperative country, exposes itself to potential US sanctions, even when all involved parties are non-US entities. More recent areas of concern include a) increased import taxes for Chinese products levied by the US, b) export restrictions for high-technology semiconductors and appliances towards China, and c) trade sanctions on Russia. Should the BRICS nations be successful in establishing a new reserve currency, backed by their respective currencies, it could significantly impact the US governance, potentially leading to a decline in political leadership, but not necessary cause the loss of the preeminent status it enjoys. Over the longer term though, this would have implications for the US and the economies gravitating around it. To grasp how the process can unfold and if history is of any guidance, then the GBP’s loss of dominance should be looked at. But for now, let’s make a flashback to the rapid rise of BRIC countries, respectively of their economies.
In 1978, under the Deng administration, China opened the country to foreign direct investments. Ever since, foreign firms invested hundreds of billions of dollars to build factories with the aim to access cheap labor and to conquer the local market. Solely for China, the yearly average foreign direct investment net balance amounted to around USD 60 billion annually. During peak periods, the net amount of DIF was exceeding USD 120 billion/annually. These flows are highly valuable for a country, especially as they are recurring. In essence, they help to manage and plan the implementation of a smooth central bank policy.
This constant flow of capital is obviously highly beneficial for local industries as it creates and upholds a virtuous wealth-creation loop. We would expect the administrations to intend to prolong this unique period to benefit from developed market capital flows which might vanish at some point if nothing is undertaken. And here is probably the weak point of BRICS. In Q2/23, the previously net positive flows turned to a net negative amount of USD 39 billion! More importantly, while the USD lost value versus all major currencies, the USD gained more than 4% in value against the Yuan. Has the tide around turned? The future will tell us.
Under the Xi administration, China aims to upgrade its economy to a service center that will be center stage to a framework to oust the US-led Western Alliance system, established at the end of World War II. After 30 or so years of wolf warrior diplomacy and recent economic and political efforts to decouple in a faster manner, China’s international image has been tarnished especially among international corporations who start to feel the pain of doing business in China. But in the meantime, China has become the world’s 2nd largest economy and whilst has issued a warning that it might enter a period of deflation.
After years of extraordinary growth, conventional wisdom would suggest that China may be entering an era of much slower economic growth resulting in weak main street demand. As of now, weakening prices can be observed for housing but also for consumer staples and discretionary. The chilling conditions in the Real Estate sector are by far not over and would expect a number of bigger defaults among property developers, financial institutions, and homeowners. The housing downturn started in 2021 and we would expect that the trend has not yet reached the mid-point!
Two more contrasting observations: a) is youth employment: At the end of Q2/23, more than 22% of the age group between 18 to 25 years was unemployed. This is somehow the unrecognized top of the iceberg as it covers some potential time with social unrest to come. B) Territorial extension: The latent conflict over Taiwan and the territorial conflict with the Philippines (it claims sovereignty of the Second Thomas Shoal, which lies within its exclusive economic zone of the Philippines), are just other examples of China’s wolf strategy and how it tries to extend its reach, be it geographically, be it politically, thereby mothballing societal advancements and effectively internal developments.
One could conceivably argue that the recent difficulties to restart the Chinese economy goes probably hand and hand with the shifting trend of negative FDI which was taken for granted and a fact of global trade. By extension, one could claim that fickler economic conditions will make it highly unlikely that BRICS CCY will ever be experienced as a tradable opportunity. Nevertheless, let’s look at the consequences of a potential BRICS CCY creation.
The BRICS nations have a batch of reasons for wanting to set up their own common currency. Recent global financial challenges, aggressive policy easing, DM-centric trade laws, and hostile US foreign policies have prompted the BRICS countries to explore the possibility. The aim of BRICS is to better serve their own economic interests while reducing global interconnections with the US dollar and the Euro.
During the 14th BRICS Summit of mid-2022, Russian President Vladimir Putin said the BRICS countries plan to issue a "new global reserve currency," and are ready to work openly with all “fair” partners. We would guess that there was much hype around the story given that the same leader is at war and he uses every opportunity to prettify things.
More recently, Brazilian President Luiz Inacio Lula da Silva openly put forward a more nuanced statement by questioning: “Why can’t an institution like a BRICS bank have a currency to finance trade relations between Brazil and China, between Brazil and all the other BRICS countries? Who decided that the dollar was the (trade) currency after the end of gold parity?”
Finally, this summer, the Bank of Russia Governor Elvira Nabiullina made a blunt but realistic statement. She commented that the idea of a BRICS currency “deserves attention”. However, she stressed that this project “will be quite difficult to implement,” emphasizing: “Like any idea of a supranational currency, it requires the consent of many parties”. Additionally, she observed: “We are still working and concentrating our efforts on the development of bilateral settlements using the national currency, the development of the infrastructure that connects our payment systems, and what businesses need today”.
This statement has somehow shed clarity on the matter – The BRICS CCY is somehow sidetracked for the immediate future. While A common currency among Russia, Brazil, China, South Africa, and China, all resources rich countries could become a balanced undertaking, the matter could become less well-adjusted and forward-looking in the event countries like Turkey, Pakistan, Egypt, and Saudi Arabia would join the currency club. The economies of the latter countries are, according to the data received, relatively different from the “founding countries”. While they have a growing and young population, which ultimately become consumers, 3 out 4 countries are beneficiaries of IMF loans!
In comparison with the EURO, we believe that the success of the BRICS CCY has somehow an important handicap. First, the economies are of a very different nature, GDP growth discrepancies are important, population growth is different, most currencies are as not freely tradable, and more importantly, location wise they are very distant, which, if the countries aim at increasing fast commercial exchange, could prove a difficult aim to achieve. The Greek default of March 2012 clearly highlights the risks for a nation with a weak economic background to join a strong union.
By definition, the pooling of forces results in more efficient cross-border transactions. More importantly, financial inclusion, if associated with blockchain technology, a common CDBC, and smart contracts, could swap the power in their favor and revolutionize the global financial system. Thanks to seamless cross-border payments, it could also promote trade and economic integration among the BRICS nations and the associated countries. Further, it could inspire other countries in Central Asia and Africa, that lack any kind of modern infrastructure to join. The broad benefits for them could be important:
In summary, for decades, the US dollar has enjoyed unparalleled dominance as the world's leading reserve currency. As it stands, the USD is used for over 74 percent of all international trade, 90 percent of currency exchanges, nearly 100 percent of oil trades, and just under 60 percent of all foreign currency reserves held by central banks. And due to its status as the most widely used currency for conversion and its use as a benchmark in the forex market, almost all central banks worldwide hold dollars as trading and reserve currency.
The expected founding members of the BRICS currency hold the majority of their central bank reserves in USD! In essence and in simple terms, BRICS nations want to establish a new currency system to compete against the establishment. Yet, they intend to be holding on to the reference points of the existing free-trade system, while at the same time, their economies are not self-sufficient.
Although the dollar's reserve currency share has decreased as the euro and yuan have gained popularity, the dollar is still the most widely used reserve currency. The USD has a share of 60 %, followed by the euro (20%), the yen, the pound, and the yuan (less than 3%).
The potential impact of a new BRICS currency on the US dollar remains uncertain. Experts are debating how BRICS CCY could potentially derail the dollar's dominance. Apparently, there is no clear-cut what could push the balance on either side. Provided, the BRICS currency would be more or less stable against the dollar, it could weaken the power of the USD and by definition the power of US central bank action and the US administration. As a further step, US imports could become more expensive, hence by extension consumers could be impacted and lose some of their purchase power.
While the concern of a rapid move toward a de-dollarization seems to be exaggerated, longer-term the concern appears to be somehow valid. The impact of a new BRICS currency versus the US dollar will depend on its rate of adoption. Pending the perceived stability (of political and economic nature) the longstanding USD hegemony could falter relatively quickly, or not! Countries like China and Russia which trade already in their alternative currency, might be joined by countries like India, Kenya, Pakistan, Turkey, and Egypt, amongst others. From the outset, these nations have one common denominator; i.e. a strong single-man leadership at the helm. But what is expected to happen when this leadership fails and no continuity can be made available?
A potential shift towards an alternative currency, significant implications for the Developed Market economies could unfold. First and foremost, the following sectors and industries are expected to face the impact:
Adjusting today an investment portfolio in response to a potential BRICS CCY might prove challenging, maybe it is a little too early. However, early drifts, if there are any, should be recognized and strategies can be developed to capitalize on the trends as they might unfold. They are:
Cash exposure:
There are a number of Money Market Funds in currencies such as BRL, amongst others.
Fixed Income:
The income segment contains a high volume of issues in local currencies in various emerging market currencies. We would expect interest rates to converge to a lower level, hence long duration bonds would benefit the most.
Equities:
While foreign direct equity investments in EMA countries are subject to segregated accounts, a number of ETFs track BRICS market indexes. Equity valuations are based on the economic outlook, sales and profit growth, and the cost of capital, amongst other ratios. Since most of these ratios were to evolve favorably, equity valuations in these countries may augment relatively quickly.
Commodities:
Investing in commodities like gold and REE companies offer a potential hedge and a valid alternative to ETF strategies. For now, the energy transition is expected to absorb most of the BRICS-produced resources. Since this is a lasting trend, one might consider investing in commodities and related anyway.
Real Estate and Private Equity:
In the same manner as for commodities, direct investments in RE and PE offer a valid alternative to ETF strategies. The issue with RE investment is that most of the advanced BRIC countries have large overcapacities in RE while at the same time, the population growth has topped out.
Investors taking the avenue of BRICS CCY should be aware of the time horizon required for the investment scenario to become a reality. In the meantime, general market risks, such as geopolitical and economic turmoil prevail. In general, emerging market assets suffer more from these events than investments in developed market countries.
The time frame for the potential launch of a BRICS CCY remains uncertain. While in the immediate run the USD predominance remains valid, longer-term concerns for a real change, whether it will be through the BRICS CCY, a substitute of it, or else, remain valid.
Recent geopolitical developments have introduced a shifting landscape and investors should pay close attention to further developments. The launch of the EURO required years of preparation and therefore we would expect the same to be true for the BRICS CCY. While not freely tradable, phasing out currencies of importance like Yuan, Rubble, Brl, Inr, and Rand requires international acceptance. More importantly, in order to make the currency reliable, one would expect, on top of common trade, one or several more common denominators that might reunite these countries. Years before the EURO was launched, the EU had a supporting framework via the European Assembly and there were the Maastricht criteria. One of the key ratios was the GDP/Debt ratio, though not many met them, the joining countries undertook targeted efforts to work towards achieving these ratios.
As of now, there are no indications available about steps in this respect. Therefore, whether the project is a dead-born idea or the need for better material conditions in emerging market countries will happen, only the future will tell us.
Knowledge is power.
